In fact, inflationary credit does have a cost. It diminishes the purchasing power of the dollar. We are being robbed year by year, and it makes no moral difference that we've all somehow gotten used to it. There are also the tremendous economic distortions that come with the practice. Inflationary credit has the effect of subsidizing some sectors beyond sustainable levels and generates waves of entrepreneurial (and consumer) errors. The business cycle itself can be laid squarely at the door of the money temple—Llewellyn H. Rockwell Jr.
In this issue
The President and the Markets "Disagree" on the CPI; Global Financial Crisis Icebreaker: The Collapse of Sri Lanka
I. The President and the Markets "Disagree" on the CPI
II. Global Financial Crisis Icebreaker: The Collapse of Sri Lanka
III. USD Php and Treasury Markets Disagrees, the BSP Relents!
IV. Not Just Cost-Push, the CPI also Manifest Demand-Pull Inflation
V. Currency Growth Spike’s Demand Pull: The Economic Reopening and Election Spending; Understanding the BSP’s Defiant Stance
VI. Spinning Inflation and Centralization as Strong Economic Growth?
VII. SMEs are the True Engine for Real Economic Growth
The President and the Markets "Disagree" on the CPI; Global Financial Crisis Icebreaker: The Collapse of Sri Lanka
I. The President and the Markets "Disagree" on the CPI
The recently inaugurated President shares a common denominator with us.
We "disagree" with the PSA on the CPI issue. But, our point of departure is in its direction.
Without saying why, for him, the 6.1% brought him a sense of "disbelief." It was too high!
But in our humble opinion, it seems inherent for the official statistical agency to understate it.
A suppressed CPI facilitates an easy money regime that promotes growth through bank credit expansion and public spending partly financed by the inflation tax. Besides, the sustained bailout of the banking system depends on loose monetary conditions.
Further, officials use an array of measures, such as biased surveys, price controls, the periodic rebasing of the index, and more, to reduce the CPI.
Besides, the CPI excludes prices of financial assets despite being part of consumer outlays.
Yet, the thing is, the most substantial argument against the CPI comes from its essence: it is impossible to quantify or average the spending activities of individuals. Everyone has different 'inflation.' The consumption basket varies from one individual to another. And the composition of an individual's consumption basket is never static or constant because it is subjectively determined; it is dynamic or consistently changes.
Therefore, because the assumption used to generate an estimated CPI is fallacious, the CPI is structurally flawed.
To return to the "disagreement." So, had the 2012 base rates been used, the CPI would have registered about 6.7%, which would signify the October 2018 high! What more if the calculation of the CPI used the 2006 base rates!
Of course, the President can act to lower the CPI; it is just a statistic anyway.
And that is the worrying part. This event may have signaled to its subordinate agencies HOW the latter should conduct the surveys that generate CPI numbers partial to his preferences.
Yet, given the path towards centralization through increased interventions, the greater the contortions, the higher the odds for policy errors. The inconvenience from one intervention leads to further actions that compound the public's discomfort.
Therefore, one intervention begets a series of further interventions until the market economy breaks.
Or using faulty data to intervene or impose variable controls on the economy should magnify the potential backlash.
But consider this too, since governments are not wealth creators but tax consumers, juggling numbers have its limits.
Ultimately, the markets decode the scale of an inflationary regime.
II. Global Financial Crisis Icebreaker: The Collapse of Sri Lanka
Figure 1
Last week's stunning collapse of Sri Lanka, which prompted the ouster of its government, should set an example.
A few days ago, Sri Lanka’s Prime Minister Ranil Wickremesinghe publicly declared: 'Sri Lanka is bankrupt.'
Its government undertook centralization through an uncontrolled public spending spree in which deficits were financed by over-indebtedness.
Monetary authorities consistently expanded the central bank’s balance sheet through the acceleration of money supply growth.
And it was not about the public sector alone.
Because authorities embraced free money via persistent low rates, the private sector likewise indulged in intense leveraging, fueling widespread malinvestments.
Personal savings growth dropped, and its stock market benchmark (Colombo All Shares) and real estate reached a milestone early this year!
But the global energy and food crisis exposed this underlying fragility: the CPI spiked, the rupee plunged, and FX reserves plummeted as the central bank used these to defend the rupee. Financial assets crumbled.
Imagine a boom, then a sudden harrowing bust!
For one thing, environmentalism may have accentuated the economic and financial meltdown of Sri Lanka.
Promoted by the West, the Sri Lankan government embraced a ban on agrochemicals and fertilizers. The epic shift to organic farming led to the terrifying collapse in yield output or harvests, which increased their reliance on imports that aggravated the domestic food crisis. Worst, the catastrophic failure of the mass organic farming ESG experiment accentuated the debt loads of farmers that likewise magnified public debt, showcasing the disastrous outcome of central planning.
Hunger, thus, forced the population to dethrone its government. This incredible video shows the storming of the Presidential Palace by protestors.
Sri Lanka appears to be the icebreaker that signifies the periphery to the core phenomenon or the domino effect on emerging markets, which are likely symptoms of an impending global financial crisis.
The social uproar and upheaval against hunger and fuel shortages appear to be snowballing globally. Reports indicate protests have intensified in many African nations. People have also risen against the government in Albania, a country in Southeastern Europe. The UN has warned of a 'looming catastrophe' from rising world hunger.
And European farmers (Netherland, Poland, Italy, and Germans) are also in protests against 'Green' carbon emission policies. The farmers are demonstrating against policies designed not just to reduce the output but also against the purported eminent domain of agricultural lands by authorities for political redistribution.
The Russo-Ukraine war represents merely a symptom of the massive backlash of the centralization of geopolitics, global economies, and finance.
III. USD Php and Treasury Markets Disagrees, the BSP Relents!
Figure 2
Returning to the Philippines, treasury traders again "disagreed" with the CPI. For them, "it remains too low and is bound to go higher!"
No one speaks for them, though. But actions at the Treasury markets reveal their perceptions.
Despite the two-rate hikes, the differentials between the yield of the 10-year Treasury and the BSP rates remain at multi-year highs. (Figure 2, upmost pane)
And while the CPI turned lower in Q1 2022, Treasury traders steepened curves to highlight inflation since early 2019. (Figure 2, middle window)
So these traders priced treasury securities that deviated from the CPI.
Again, who turned out right?
Of course, the popular scapegoat by the consensus is the anticipated actions of the US Federal Reserve. That is to say, no wrong can befall the decision of our policymakers! Exogenous forces are the cause of the present defects.
Yet they fail to observe that probable actions of the FED are in response to the raging inflation. Their causation runs backward.
This week, the yields of the front end climbed in anticipation of the BSP's move. (Figure 2; lowest window)
But the rise in the front-end implies a flattening of the treasury slope, which again are potential indicators of depletion of liquidity.
Figure 3
Currency traders also "disagreed" with the CPI and the BSP, so they bid up the USD to reach levels last reached in 2005! (Figure 3, topmost pane)
From the alleged "stable" peso, the narrative has shifted. The Inquirer headline shows, "Peso now region’s worst performer".
"Never Believe Anything Until It Is Officially Denied." Confirmed! We are vindicated! (Prudent Investor Newsletter, 2022)
Because both the Treasury spreads and the FX markets (USD-Php) have vastly surpassed 2018 levels, the 'real' inflation rate must be substantially higher than official metrics constructed by the Philippine Statistics Authority (PSA).
Most importantly, contrary to the "transitory" meme, it is a long-term uptrend for the CPI.
Unlike in the past, the BSP has presently limited publishing data, restricting its coverage span from only 2018.
When implementing a policy, the penchant of the BSP is to justify it with global standards (e.g. bank reserves, interest corridor and more).
Curiously, against this global rule, the BSP has even eliminated the CORE CPI category. They even stopped publishing the quarterly inflation report! The question is: why? Or why restrict the availability of the CPI data to the public?
Nevertheless, we superimpose the shaved 2018 version with the 2012 data to exhibit the long-term climb from 2015.
With the 1.5% plunge this week, the peso is now the worst-performing currency in the region YTD (ex-Japanese yen)! The Philippine peso was the second-worst performer year-on-year (YoY) after the South Korean won. (Figure 3, lowest right pane)
The volatility of the peso appears to be mounting. Weekly change is at the highest level in years! (Figure 3, lowest left pane)
Public pressure on the peso will force the BSP to step up on its interventions. And this should lead to more pressure on its Gross International Reserve (GIR), which fell for the fourth straight month, last June. The BSP has been offloading its Other Reserve Asset (ORA) of its GIR, reducing support for the peso. Data from the IMF’s International Reserve and Foreign Currency Liquidity (IRFCL). (Figure 3, second to the lowest pane)
The sage of Omaha, Warren Buffett, presciently warned, "You don't find out who's been swimming naked until the tide goes out."
Yet again, the current moves of the USD Php reinforce its 52-year uptrend.
Authorities can always conjure roseate interim targets while ignoring structural forces and discarding trend cycles.
Not only will they keep missing their goals, but they will have to keep adjusting these higher.
Proof?
ABS-CBN News (July 9): The Bangko Sentral ng Pilipinas is prepared to raise interest rate by 50-basis points in its Aug. 18 meeting, BSP Governor Felipe Medalla said, as inflation soars and as the peso weakens further…"When we have to because of inflation, we normally raise our policy rate (the interest we pay on our overnight borrowing from banks to guide bank lending rates) by only 25 basis points in one meeting," Medalla said. "That we are going to raise by 50 in our next meeting this August means we are not as gradualist as before," he added.
Because political authorities depend on their subjects for survival, economics prevails over politics, ultimately.
That said, the markets have forced the hand of the BSP.
The odd thing is, while a 50 bps increase is more than the 25 bps, it still looks like a 'gradualist' regime because the 'real' yield remains negative!
IV. Not Just Cost-Push, the CPI also Manifest Demand-Pull Inflation
The establishment consensus tells us that supply-driven/cost-push inflation is the cause of the rising CPI.
In this case, the implication is that money supply growth, the 'real' measure of inflation channeled through credit expansion, has little bearing on domestic demand/demand-pull inflation.
Applying the ideological Turing Test, we assimilate the mainstream jargon of demand-pull and cost-push inflation.
But the supreme paradox is that when rationalizing the GDP, these experts babble about the ingredient that supposedly plays a minor role in the CPI: Domestic Demand!
So which is which?
What is more, if domestic demand plays a subordinate role in the CPI, why are prices rising across a broad spectrum of products and services?
Let us put it this way, downplaying the credit-financed demand justifies the current loose monetary stance.
And so, the public discourse on the CPI attempts to draw sentiment away from domestic factors and allude to external forces as the culprit.
Perhaps, counseled by advisers, the President rationalizes the CPI as "imported inflation."
But then, almost all of the experts seem obsessed with public spending. Have they forgotten that infrastructure and welfare spending impacts prices and circulates in the economy?
Figure 4
Can they not see that the upside trend in the CPI coincides with the ascent of public spending? (Figure 4, topmost window)
And that's not all.
Aside from the credit build-up on the supply side, consumers are leveraging their balance sheets to augment the loss of purchasing power. (Figure 4, middle pane) The banking system's credit card portfolio topped the January 2020 level to etch a record high (in peso)!
How does the intensified use by consumers of credit cards impact retail prices?
Is the supply side or manufacturers producing more to offset the demand increase?
But manufacturing has also been a principal beneficiary of the latest bank expansion. (Figure 4, lowest window)
The soaring Producer's Price Index (PPI) has also corresponded with the strong demand by this sector for bank credit.
Continued shortages and logistics and transport woes may have prompted producers to use bank credit to hoard raw materials for future production. By stockpiling, producers intend to protect present margins against sustained price increases.
Once again, the S&P Markit provides a clue: Similarly, both pre- and post-production inventories increased at a softer pace compared to that seen in May but remained modest overall as firms noted rising business requirements. On the price front, average cost burdens rose further as companies continued to register higher energy and raw material prices. While the rate of inflation eased for the third month running, it remained sharp overall. With average cost burdens rising, firms continued to pass greater input prices on to their customers. Output prices also markedly, albeit at a softer pace compared to May. (Baluch and Vickers, 2022)
Nonetheless, the S&P Markit June survey further noted a divergence between local and foreign demand for locally produced goods: "Despite a loss in growth momentum for the second month running, operating conditions have now improved for five successive months, with the headline PMI figure signalling solid overall growth in the manufacturing sector. Moreover, production levels increased at the second-fastest pace since November 2018. Anecdotal evidence noted higher customer demand prompted greater output in June. Driving the rise in production, factory orders received at goods producers also increased at an accelerated pace in June. That said, export volumes contracted again, as has been seen in each month since March. Weak international client demand and supply issues reportedly led to diminished volumes of new work from abroad."
While job growth appears to have stalled: "With activity picking up at manufacturing firms, employment levels rose for the second successive month in June. While the rate of job creation was only mild and eased from May, the rise in workforce numbers was linked to greater production requirements and increased new orders."
Nonetheless, since PPI rates have risen faster than the CPI, a profit margin squeeze may have already plagued the sector's clients (wholesalers and retailers).
Figure 5
And manufacturing sales data likewise suggest that the rate of increase is a symptom of the money illusion: value growth has outsprinted the volume by a mile.
June sales value growth of 18.8% eclipsed volume growth of 4.33% by over 4x! (Figure 5, topmost pane)
Have credit financed spending activities in three sectors, namely public spending, household credit, and the manufacturing industry, been insufficient to spur demand to fuel prices higher?
We exclude credit-driven demand from the banks, imports, information and communication, and the labor force.
V. Currency Growth Spike’s Demand Pull: The Economic Reopening and Election Spending; Understanding the BSP’s Defiant Stance
But there is more.
To rescue the banking system, the BSP’s record infusion of Php 2.3 trillion prompted a growth spike in the monetary base or currency issuance in mid-2020. (Figure 5, middle window)
Currency issuance growth spiked by 32.4% in May 2020 and grew by over 20% in the next 9-months.
Since growth dropped to near zero in May 2021, currency issuance by the BSP resumed its sharp upside growth of 10% from January 2022 through May.
Where did the cash hoard flow?
True, the banks absorbed a substantial segment in 2020, but money is not static.
For one thing, the belated reopening of the economy delayed its transmission to the economy, which eventually affected prices. In any case, the election spending binge signified part of its past and present dispersion of unprecedented cash issuances.
Yes, supply/cost-push represents a factor, but so is demand-pull.
In the last analysis, in the understanding that the previous surge in the CPI in 2018 led to increases in Non-Performing Loans (NPL), it seems that keeping rates low remains the only card the BSP can use to prevent a disorderly credit deflation in the industry. (Figure 5, lowest pane)
Recall that the banking system still operates under the lifeline of the BSP through various relief measures, thereby their defiant stance, which the markets have challenged.
We are on the path toward a stagflationary environment.
VI. Spinning Inflation and Centralization as Strong Economic Growth?
It is incredible for authorities to predict strong growth even when they extend bailouts or 'targeted subsidies' to sectors most pained by rising fuel and commodity prices, which reached Php 6.1 billion.
The crisis in the transport sector, which has spurred some shortages in public transport, prompted authorities to raise the cap on fares by Php 2 starting this July.
As previously explained, these shortages represent a textbook response to price controls.
Yet the capping of prices is barely about protecting the consumers but about restraining the CPI.
It is not about protection when passengers are either deprived of convenience or lose access to transport services.
The offshoot is the loss of productivity of workers and the companies that employ them.
And it isn't growth when financial losses from the pandemic lockdowns compel a college to close doors.
Inquirer, July 6: Twenty-two years after its establishment, Kalayaan College (KC), a nonsectarian private institution founded by professors from the University of the Philippines (UP), announced on Tuesday that it would cease its operations, citing the financial challenges brought about by the COVID-19 pandemic. In an advisory, KC president Ma. Oliva Domingo said they were “faced with no other options” but to shut down because of the plunge in enrollment that caused “continuing” financial losses to the institution.
The school’s experience reveals the industry’s trend toward centralization and monopolization.
Hurt by low investments, joblessness, forced shutdown due to the pandemic, and reduced purchasing power, the middle-class demand for private education has diminished.
In turn, schools catering to this sector may be shrinking.
In its place, public schooling will rise, adding to the fiscal deficits financed by debt or inflation, or both.
And so, with public schools expanding to substitute for the shriveling number of private-sector schools, the education sector shifts towards increased centralization.
But inflation favors some groups at the expense of the citizenry.
So families that benefit from BSP policies and the regulatory, tax, and welfare regime, coming from political institutions and well-connected elite private firms, are likely to enroll in schools of the wealthy.
Extending the logic above, while middle sector schools shrink, schools of the elites prosper. That should represent policy-induced monopolization.
This dynamic may be growth for the beneficiaries of political policies, but how can this be reckoned as economic growth?
VII. SMEs are the True Engine for Real Economic Growth
Finally, the previous administration indeed passed several investment-friendly edicts.
But most of these investment enticements are primarily designed for the big players. Unknown to most, trickle-down policies anchor such an investment regime, where big-ticket investors are required to associate with politicians and the bureaucracy.
Most people fail to realize that in 2020, Small and Medium Enterprises (SMEs) comprised 99.5% of all businesses and 63% of the total employment, according to the Department of Trade and Industry. Ironically, the large companies delivered 64% of the economic value-added. This striking divergence reveals the implicit biases of domestic economic policies. These newly passed laws only reinforce such prejudice.
And it is one thing to open select sectors for investments while imposing a barrage of regulatory hurdles on operations. Expansive public control over resources and finances crowds out the SMEs too.
Real economic growth emanates from SMEs, the grassroots entrepreneurs. Unfortunately, the incumbent monetary, tax and regulatory policies skew the economic playing field favoring large companies at their expense.
