The risk of catastrophe will be very high. The nation could erupt into insurrection or civil violence, crack up geographically, or succumb to authoritarian rule. If there is a war, it is likely to be one of maximum risk and effort – in other words, a total war. Every Fourth Turning has registered an upward ratchet in the technology of destruction, and in mankind’s willingness to use it– Strauss & Howe: The Fourth Turning
In this issue
Is the Philippine Peso Immune from the Rising Risk of a Sino-Philippine Military Conflict? Why the Silence over its Risks?
I. Reverse Psychology? Philippine Peso as One of Asia’s Worst Performing Currencies?
II. Blissful Oblivion or Willful Negligence: Is the Philippine Peso Immune to the Growing Risk of a Military Conflict?
III. Asian Currencies in the Shadow of a Strong US Dollar
IV. The Gross International Reserves is no Talisman Against the Uptrend of the USDPHP
V. The BSP’s Increasing "Borrowed Reserves"
VI. The Trickle-Down Political Economy’s Dependence on "Twin Deficits" Depletes FX Buffers
VII. Thinning FX Buffers: Slowing Remittances and Tourism, Debt-dependent FDI, and Volatile Foreign Portfolio Flows
VIII. USDPHP is Driven by the Real Economy; Questioning a War-Hawkish Public and Financial Experts, "You Two Are Discussing the Same Country, Aren't You?"
Is the Philippine Peso Immune from the Rising Risk of a Sino-Philippine Military Conflict? Why the Silence over its Risks?
While the local media is abuzz with the worsening standoff in the territorial dispute between the Philippine government and China, and the Philippine Peso nearing record levels, financial experts are oddly silent about the economic risks involved.
I. Reverse Psychology? Philippine Peso as One of Asia’s Worst Performing Currencies?
Figure 1
Mainstream experts seem more confused than ever about the state of the US dollar-Philippine peso $USDPHP.
As the $USDPHP approaches a milepost, they appear to be sugarcoating the fragility of the Philippine peso by attributing the peso’s weakness to the divergent policy conditions between the US Federal Reserve and the Bangko Sentral ng Pilipinas (BSP). (Figure 1, topmost image)
They are actually defending the Philippine peso when they allude to the strength of the US dollar, the elevated Gross International Reserves (GIR), and other possible BSP toolkits.
Using what seems as reverse psychology, a foreign institution even projected that the peso would "become one of Asia’s worst-performing currencies," given the BSP’s ‘dovish’ stance. (Figure 1, middle visual)
Bizarrely, they placed a marker for this: the USDPHP would "hold at 58 per dollar, although it may weaken to as low as 58.60, which would be a few centavos away from the record-low 59 it hit in 2022."
Amazing.
The thing is, the news was hardly a projection; it was a description of present events.
The USDPHP signified the fourth worst currency in Asia (year-to-date), after the Japanese yen $USDJPY, South Korean won $USDKRW, and Indonesian rupiah $USDINR—as of June 21st. (Figure 1, lowest chart)
By placing a boundary for the "worst in Asia" assumption to hold, it translates to either a positional stasis or that most Asian currencies would do better because of the so-called ‘dovish’ stance of the BSP.
Figure 2
Ironically, the nominal yield spread between the 10-year Philippine BVAL and US Treasury bonds has been rising in favor of the former.
Operating under the belief of arbitrage opportunities, the consensus thinks that relatively higher (nominal) rates for the Philippine Treasury should favor the peso.
But this dynamic has barely been the case, as a relatively lower Philippine yield has coincided with a strong peso and vice versa from 2019 to Q1 2022. Since then, USDPHP has climbed ahead despite the spread—or the correlation broke from Q2 2022 to the present. (Figure 2, topmost diagram)
In brief, this loose correlation does not support the popular thesis.
II. Blissful Oblivion or Willful Negligence: Is the Philippine Peso Immune to the Growing Risk of a Military Conflict?
Here is what the Overton Window critically overlooks: the escalating standoff over the territorial dispute between the Philippines and the Chinese government.
Haven't you noticed? The Sino-Philippine West Philippine Sea showdown has been splashed all over mainstream media. Despite this, there is nearly ZERO attribution about it to the Philippine peso or the Philippine economy. This stark contrast underscores the disconnect between the intense diplomatic and military tensions and the lack of insights into its potential economic fallout.
That is to say, while the risks of the Philippines becoming the Ukraine of Asia grows with every confrontation, the consensus oxymoronically sees such risks as non-existent.
Could they be talking about the Philippines? Why the complete absence of the mounting risks of war?
This seemingly incredible blindness represents either "blissful oblivion" or "willful negligence" over the possible cataclysmic risks from an outbreak of violence.
As I recently posted on my X (formerly Twitter) account, at the onset of wars, the currencies of those involved—namely the Russian ruble $USDRUB, Ukraine’s hryvnia $USDUAH, and Israel’s new shekel $USDILS—materially fell against the US dollar. (Figure 2, lower image)
That's a blueprint for the Philippine economy that we should expect when water cannons and knives escalate into a shooting battle.
Aside from a possible plunge in the Philippine peso, depending on the scale of war, we can expect a double "deep" recession, a possible stock market crash (if it remains open), rolling brownouts—when power plants become military targets—which means disruptions in digital payments and bank ATM withdrawals, massive disruptions in the division of labor, and the BSP printing more money—which leads to stagflation!
While we earnestly pray that this does not happen, as there are other peaceful options like Vietnam’s "bamboo diplomacy," the Asian version of foreign policy neutrality, it is a risk that every Philippine resident confronts as contending parties to territorial claims remain intransigent and lean on belligerency.
Although we won’t expand further on the geopolitical dimension of the rising risks of a Sino-Philippine military conflict, it's crucial to note that the US dollar-Philippine peso exchange rate is not insulated from these rising tensions.
My brief two cents on the Philippine government’s turnaround regarding the alleged "armed aggression" of China in an X thread.
III. Asian Currencies in the Shadow of a Strong US Dollar
Operating under the de facto US dollar standard, the US and its political, economic, and financial activities overseas have a distinctive impact on the world.
In addition to the transition away from globalization and domestic politics, geopolitics is another key factor contributing to the recent increasing value of the USD.
An abrupt rise in the US dollar is often a sign of emerging economic distress.
Figure 3
Unlike its popular portrayal, the rising value of the USD is not an anomaly.
Using the US dollar index $DXY as a benchmark, it has been in an uptrend since 2021, supported by a reverse head-and-shoulders pattern. More importantly, the longer-term trend shows a 9-year uptrend. (Figure 3, topmost and second to the highest graphs)
The $DXY is composed of a weighted basket of developed economy currencies, including the European euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.
The uptrend in the USD is evident across several ASEAN currencies, including the Indonesian rupiah $USDIDR, the Philippine peso, the Malaysian ringgit $USDMYR, and the Vietnam dong $USDVND, though it's not shown in the chart. (Figure 3, second to the lowest chart)
In the long term, however, the USD has underperformed against the Thai baht $USDTHB and Singapore dollar $USDSGD. (Figure 3, lowest window)
Using the mainstream's logic, the Bank of Indonesia (BI) unexpectedly raised rates in April in an attempt to "anchor the rupiah". Despite this move, the $USDIDR pair carved out a milestone high last week. Was the BI's decision still "dovish"?
The essence lies in the fact that Asian currencies exhibit asymmetric performances that are underpinned by their idiosyncratic or unique domestic conditions.
A sweeping generalization of a strong USD represents a fallacy of composition.
IV. The Gross International Reserves is no Talisman Against the Uptrend of the USDPHP
Figure 4
More intriguing is the widespread conviction that the country's foreign exchange reserves (GIR) serve as a talisman against the rising US dollar, which appears to be more of a manifestation of faith or defending piety than an analysis based on economic theory and data.
If this belief were valid, then $USDPHP pair would have underperformed. Alternatively, there wouldn’t have been an uptrend in $USDPHP if the GIR had functioned as advertised. (Figure 4, topmost image)
Instead, we see that the GIR fell upon its drawdown by the BSP to defend the peso when the $USDPHP carved a record in 2022.
Ironically, the BSP accelerated its accumulation of GIR in 2019-2020 just at the late stage of the peso's rally.
Since then, it has been a tango for the GIR and USDPHP as both proceeded higher.
Separately, as evident from the BSP's annual balance sheet, the strength of the $USDPHP has coincided with an increasing percentage share of BSP's local currency issuance against its total liabilities. (Figure 4, middle chart)
In short, the primary driver of the USD/PHP's uptrend has been the BSP's money printing operations, not the GIR.
V. The BSP’s Increasing "Borrowed Reserves"
Furthermore, what authorities say is often taken as "gospel truth," with few questioning the numbers behind them.
Let us turn to the GIR.
The Philippine government borrowed USD 2 billion in early May.
The BSP described the increase in its GIR for the same month as follows: "The month-on-month increase in the GIR level reflected mainly the National Government’s (NG) net foreign currency deposits with the Bangko Sentral ng Pilipinas (BSP), which include proceeds from its issuance of ROP Global Bonds, and net income from the BSP’s investments abroad." (BSP, 2024)
Subsequently, the BSP also disclosed that its Balance of Payments (BOP) showed a surplus during the same period: "The BOP surplus in May 2024 reflected inflows arising mainly from the National Government’s (NG) net foreign currency deposits with the Bangko Sentral ng Pilipinas (BSP), which include proceeds from its issuance of ROP Global Bonds, and net income from the BSP’s investments abroad." (BSP, 2024)
See that? The BSP admitted that "borrowed reserves" has constituted a part of its GIR and BOP. Hence, the USDPHP ignored them and proceeded higher. (Figure 4, lowest graph)
Figure 5
May’s US dollar borrowings will likely add to the USD 128.7 billion of external debt, which was up by 8.32% in Q1 2024. (Figure 5, topmost graph)
External debt has soared past the BSP’s GIR of USD 104.1 billion for the same period.
Yet, as acknowledged by the BSP, part of external debt has been incorporated into the GIR.
There’s more to consider.
As the Philippines’ April GIR showed, based on IMF’s International Reserves and Foreign Currency Liquidity (IRFCL), the BSP has been selling off its gold reserves and has boosted its use of Other Reserve Assets (ORA). The BSP’s physical gold reserves last April signified a multi-year low! (Figure 5, middle pane)
Other Reserve Assets comprise financial derivatives, short-term currency loans, repos, and other liquid assets. (IMF, IRFCL)
During the international easy money era, ORA became a feature in the GIR build-up from 2018-2020 and the rally of the peso. (Figure 5, lowest chart)
However, rising costs compelled the BSP to reduce its use in 2022. Nonetheless, the BSP returned to it last April 2024.
The thing is, "borrowed reserves" represent "US dollar shorts," which is attendant with an increasing likelihood of maturity mismatches, especially during times of stress.
Furthermore, "borrowed reserves" will need payment or refinancing. The greater the borrowings, the higher interest payments, refinancing, and principal payments, even in the assumption of steady rates, which translates to increased pressure for organic sourcing of USD revenues.
Otherwise, the economy and government would be forced to continue borrowing externally to meet growing USD liquidity needs, while increasing domestic liquidity, which would amplify the pressure for the Philippine peso to depreciate further.
VI. The Trickle-Down Political Economy’s Dependence on "Twin Deficits" Depletes FX Buffers
Given the entrenched "trickle-down" political-economic architecture driving the borrowing-to-spend (to prosperity) paradigm, which has engendered a record savings-investment gap, it is difficult to envision a structural shift in the current dynamics—specifically, a transition away from debt dependence—without a disorderly adjustment.
Underpinned by Keynesian ideology, the establishment has made little or no effort to promote this essential structural change.
Rather than acknowledging the accruing tradeoffs from transitioning to a centralized political economy anchored in fiscal spending (infrastructure and the war economy) and increasing bureaucratization, the consensus continues to promote the illusion of a consumer-driven economy.
Figure 6
A strengthening economy would swell trade deficits, given the structural shortcomings in local production, while an acceleration of the fiscal deficit would magnify the credit-financed "twin deficits."
As evidence, April’s trade deficit expanded as imports grew by 12.6%, driven by increases in capital imports (+10.5%) and consumer goods (+15.7%). (Figure 6, top, middle and lowest chart)
Therefore, authorities would need to rely on remittances, tourism, service exports, FDIs, foreign portfolio flows, or borrowings to cover the FX deficits.
VII. Thinning FX Buffers: Slowing Remittances and Tourism, Debt-dependent FDI, and Volatile Foreign Portfolio Flows
Figure 7
Despite record-high nominal Overseas Filipino Workers (OFW) remittances last April, their growth rate has been slowing down primarily due to base effects.
Moreover, remittance flows are heavily influenced by global economic conditions, which may face hurdles from increasing barriers to social mobility. For instance, rising economic barriers and increased nationalism are expected to slow OFW flows.
On the other hand, vigorous tourism growth in 2023, fueled by strong domestic "revenge travel" and improved foreign arrivals, appears to have cooled down in 2024.
While FDI flows seem to be improving, the majority of these flows consist of debt. Reported FDI flows were up 23% last March and 42% in the first quarter, with debt accounting for 68% and 62% of the share, respectively.
Intercompany debt infusions do not guarantee genuine investments. Instead, they expand the USD shorts.
Additionally, taking sides in the geopolitical hegemonic contest could deter investors, making politics rather than markets the determinant of investment flows.
Meanwhile, volatile flows from foreign portfolio exposure cannot be relied upon to boost demand for the peso. This is primarily due to the structural inadequacy of the capital markets' depth (PSE and the fixed income market), which remain dominated by the elites.
Another fundamental reason is that portfolio flows are heavily dependent on global risk conditions.
Lastly, services exports appear to be the remaining hope to cushion the peso via USD revenues. So far, the industry is said to be on track to meet its growth targets this year.
However, any slowdown in this sector would exacerbate USD funding pressures.
VIII. USDPHP is Driven by the Real Economy; Questioning a War-Hawkish Public and Financial Experts, "You Two Are Discussing the Same Country, Aren't You?"
It is clear that the USDPHP has not been primarily driven by BSP-FED policy divergence but by real economic factors, including the BSP’s domestic monetary operations.
If the current arrangements have resulted in thin buffers, imagine what an outbreak of military conflict would do.
The striking divergence between a war-hawkish leaning public and the absence of discussion about its risks in the domestic financial sphere reminds me of the glaring disparity in the fact-finding report by two of former US President John F. Kennedy's foreign policy advisors, Victor Krulak and Joseph Mendenhall, on Vietnam. President Kennedy reportedly asked both, "You two did visit the same country, didn't you?"
Paraphrasing Kennedy and alluding to local media and domestic financial experts, "You two are discussing the same country, aren't you?"
_____
References:
Bangko Sentral ng Pilipinas, End-May 2024 GIR Level Rises to US$104.48 Billion June 7, 2024, bsp.gov.ph
Bangko Sentral ng Pilipinas, BOP Posts US$2.0 Billion Surplus in May 2024; End-May GIR Rises to US$105.0 Billion June 19, 2024 bsp.gov.ph
International Monetary Fund, INTERNATIONAL RESERVES AND FOREIGN CURRENCY LIQUIDITY GUIDELINES FOR A DATA TEMPLATE, p.25 imf.org
