Chart of the Day: Debt Monetization represents a Policy of Devaluation!

Debt Monetization as explained by the Financial Times Lexicon: (bold added)

When a government spends in excess of its tax revenue it must borrow from the public. The public purchases this debt because it pays an attractive interest rate. If the government has a significant amount of debt outstanding, it may choose to purchase its own debt with newly printed currency. The government has thereby replaced its interest-bearing debt with money, and has thus monetised part of its debt.

Inflation is an unfortunate consequence of debt monetisation. The public was willing to hold the government’s debt as part of its investment portfolio because the debt paid an attractive interest rate, but the same is not true for the newly printed money.

A consequence of purchasing debt with money is that now the supply of money exceeds its demand. An attempt to purchase goods and assets with this excess money supply will drive up prices, thus generating inflation. Indeed, debt monetisation to finance a deficit is referred to as inflationary financing of the deficit.

USD-PHP Hits Eleven Year High! The Government’s Ambitious Infrastructure Projects Should Aggravate on the Peso’s Predicaments

The USD-Php beat the Phisix to a new record.

Up .5%, the USD-Php soared to 50.47 a level last reached in September 2006, or an ELEVEN year high!

Among Asian contemporaries, the USD-Php was the strongest again this week (peso weakest)

The domestic currency’s weakness has been more than the USD. It has been weak against a broad spectrum of currencies.

 

Among the currency majors, with the exception of the Japanese yen, the Philippine peso has attenuated against the euro, pound and the yuan over the past year (upper charts). The yen has risen against the pesoin January but has traded rangebound since May. (But the yen-php remains up on a year-to-date basis)

Including all the components of the Bloomberg Dollar index (BBDXY), the Philippine peso has diminished against the Mexican peso, the Australian dollar, and the Swiss franc. The Canadian dollar has only recently spiked against the peso. Though the Brazilian real rose against the peso in the first two months of the year, such gains have dissipated. Or the peso has gained only against the real year-to-date. The real’s weakness has largely been due to corruption scandal that has surfaced to plague Brazil’s new administration.

The peso has condescended even against the ASEAN neighbors, namely the ringgit, baht and rupiah (lower window).

Despite the much ballyhooed G-R-O-W-T-H mantra, the broad spectrum of the peso’s weakness has been amazing.

Contrary to the public wisdom, the sustained softening of the peso entails that the demand for the peso (and peso related assets) continues to wane.

Moreover, while there has been a surfeit of domestic liquidity, there appears to be increasing scarcity in the context of USD liquidity in the domestic financial system.

And while local experts fixate on the FED’s “hawkishness” the international counterparts have raised the issue of USD flows in terms of remittances and of trade deficits. Hardly has there been any meaningful discussion on relative supply side factors.

On remittances. Unless much of the domestic population will be sent overseas, the law of diminishing returns will continue to dominate remittance dynamics predicated on the sheer scale of OFWs and overseas migrant workers.

Additionally, incomes of OFWs and immigrants depend or are leveraged on the global economy. With global debt at a staggering US $217 trillion or 325% of GDP in 2016(!), the burden of debt servicing will hardly generate enough room for investments and therefore provide the necessary fulcrum for growth dynamics. Furthermore, since much of these debts had been used to finance overcapacity, the latter will also serve as obstacles to real economic growth. Both these factors parlay into constricted demand.

Moreover, increased risks of protectionism and political aversion to migrants will likely serve as added hurdles to increased overseas deployment. Given these factors, remittance growth should be expected to grow incrementally, stagnate or even decline.

This brings us to trade deficits.  The government proposes an aggressive infrastructure spending program to the tune of Php 8 to 8.4 trillion over the tenure of the incumbent administration (2017-2022).

To put in perspective the scale of the proposed spending, 2016’s NGDP was at Php 14.5 trillion. The personal savings as of May was Php 4.09 trillion. Total resources of the financial system as of April totaled Php 17.4 trillion with banking system’s resources at Php 14.142 trillion. This means that that the proposed infrastructure spending program would equal 55% of NGDP, 195% of personal savings and 46% of the financial system’s resources. And that’s just infrastructure alone.

Since the government’s massive infrastructure spending alone will compete and eventually “crowd out” the private sector on resources and on financing, these most likely will lead to even bigger trade deficits (greater imports than exports). With insufficient dollar flows from remittances and from foreign investments (as consequence of “crowding out”), the government’s current dollar liquidity predicament will likely intensify. The government will most likely finance such liquidity shortages with more borrowing from both local and international sources of USDs, the BSP will probably increase its usage of derivatives “forward cover” and possibly resort to access of currency swaps with other central banks.

So the government will not just be borrowing to finance its ambitious spending programs, it will also expand its leverage on the USD for liquidity purposes. At the end of the day, increasing dollar indebtedness would redound to magnified “US dollar shorts”.  

And while popular politics remain fixated on free lunch funded pipe dreams, raging global asset markets may have been forcing global central banks to have second thoughts on the continued provision of easy money.

Fed officials as Ms. Janet Yellen warned last week of expensive price valuations. San Francisco Fed John Williams said the stock market "seems to be running very much on fumes" and that he was "somewhat concerned about the complacency in the market." (Bloomberg)

Ms. Yellen’s vice chair, Stanley Fisher “pointed to higher asset prices as well as increased vulnerabilities for both household and corporate borrowers in warning against complacency when gauging the safety of the global financial system.” (Bloomberg)

The Bank of England “ordered banks to hold more capital as consumer debt surges” (The Guardian) while its governor Mark Carney gave the case of raising interest rates (Marketwatch)

European Central Bank’s Mario Draghi hinted that tapering of QE may be in the offing by saying “deflationary forces had been replaced by reflationary ones”.

Mr. Draghi’s statement sparked massive selloffs in bonds, and a huge spike in the euro!

ECB officials tried to downplay Mr. Draghi’s statement to no avail.

The Swedish Central Bank is widely expected to ditch its easing bias next week.

Last weekend, prior to the spate of hints by central banks, the Bank for International Settlements, the central bank of central banks, urged major central banks to press ahead with interest rate increases (Reuters)

And with major central banks signaling a concerted tightening, it’s a wonder how the Philippine government can be able to finance their proposed grandiose project.  

Aside from domestic USD liquidity issues, if the BSP continues to maintain current historic subsidies in the face of global tightening, the peso will depreciate further. Monetary subsidies include the RECORD lowest interest rate and the RECORD monetization of National government debt which went up by 8.9% in May 2017 from April’s 4.3%.

But if the BSP raises its rates to align with actions of the other major central banks, then just what happens to the much touted aggressive infrastructure spending projects?

Oh by the way, I noted in early June that the BSP has imposed a tacit tightening through a pullback in the monetization of national government’s debt. (Oh My, Has the BSP Commenced on Tightening??? June 4, 2017).

Apparently, the slowing domestic liquidity growth (11.3% in May) has percolated to impact consumer (+23.6%) and industry loan (+17.6%) growth too (lower window).

Nevertheless, the BSP seemed to have used QE (Php 31.783 billion) anew this May to finance the National Government May’s fiscal deficit (Php 33.421 billion). The doubling of growth rate has similarly reflected on M3.

Getting hooked to debt monetization translates to a policy of devaluation.

Oh, before I close, here is a SHOCKING quote of the day from Ms. Yellen (Reuters, June 27, 2017)

U.S. Federal Reserve Chair Janet Yellen said on Tuesday that she does not believe that there will be another financial crisis for at least as long as she lives, thanks largely to reforms of the banking system since the 2007-09 crash.

"Would I say there will never, ever be another financial crisis?" Yellen said at a question-and-answer event in London.

"You know probably that would be going too far but I do think we're much safer and I hope that it will not be in our lifetimes and I don't believe it will be," she said.

Writing on the wall?

Signs of Crack-up Boom in China? Copper Premium Surges as Yuan Weakens

Bloomberg’s chart of the day shows that copper prices in China appears to be diverging from global prices copper due to the yuan's weakness…

Even as London copper prices remain mired near their lowest since 2009, the premium paid for the metal in the Chinese port of Yangshan is at a three-month high.

Buyers who haven’t locked in long-term supply are driving gains on fears that further depreciation in the Chinese currency will only make the metal more expensive in yuan terms, according to analysts at SMM Information & Technology Co. and Maike Futures Co. in Shanghai.

The above chart from Stockcharts.com shows of the USD price of copper.

When people buy commodities not because of economic demand but on fear of devaluation (inflationism), they represent flight-to-real values or the attempt to safe keep savings via commodities/real assets or the crack-up boom

The great Austrian economist Ludwig von Mises once warned, (bold mine)

The policy of devaluation has to some extent altered this typical sequence of events. Menaced by an external drain, the monetary authorities do not always resort to credit restriction and to raising the rate of interest charged by the central banking system. They devalue. Yet devaluation does not solve the problem. If the government does not care how far foreign exchange rates may rise, it can for some time continue to cling to credit expansion. But one day the crack-up boom will annihilate its monetary system.

So how does the crack-up boom emerge? The great Dean of the Austrian school of economics Murray N. Rothbard explained: (bold mine)

At first, when prices rise, people say: "Well, this is abnormal, the product of some emergency. I will postpone my purchases and wait until prices go back down." This is the common attitude during the first phase of an inflation. This notion moderates the price rise itself, and conceals the inflation further, since the demand for money is thereby increased. But, as inflation proceeds, people begin to realize that prices are going up perpetually as a result of perpetual inflation. Now people will say: "I will buy now, though prices are `high,' because if I wait, prices will go up still further." As a result, the demand for money now falls and prices go up more, proportionately, than the increase in the money supply. At this point, the government is often called upon to "relieve the money shortage" caused by the accelerated price rise, and it inflates even faster. Soon, the country reaches the stage of the "crack-up boom," when people say: "I must buy anything now—anything to get rid of money which depreciates on my hands." The supply of money skyrockets, the demand plummets, and prices rise astronomically. Production falls sharply, as people spend more and more of their time finding ways to get rid of their money. The monetary system has, in effect, broken down completely, and the economy reverts to other moneys, if they are attainable—other metal, foreign currencies if this is a one-country inflation, or even a return to barter conditions. The monetary system has broken down under the impact of inflation.

Has rising domestic copper prices in China been revealing of the incipient transition phase towards a crack-up boom?

The Real Economy Effects of a Weak Currency: Collapsing Ringgit Hurts Small and Medium Scale Enterprises and Increases Credit Risks!

Unlike the Philippines where the weak peso has been propagandized as having mostly beneficial effects, Malaysian media explains its real economic devastating impact.

First let me use a weak currency’s the transmission mechanism on imports, production, profits and economic transactions. Below I used the Peso as example:

Domestic prices of imported goods and services will RISE. So whatever alleged gains from a lower peso on OFW will be largely offset by the price increases on imported goods and services. And rising prices should REDUCE demand for imported goods.

For domestic production, prices of imported production inputs will also increase. Rising input costs should put a squeeze on the profits of producers. And profit margin strains will mean lesser investments, which subsequently should extrapolate to lesser outputs and diminished jobs and wage improvements.

And lesser production output means HIGHER domestic prices. In short, again whatever gains from the lower peso on OFW, exports, BPOs and or tourism will be mostly neutralized by rising domestic prices overtime.

And again, the ascendant domestic prices have been the effects of higher import prices.

Moreover, in the financial dimension, any USD based liabilities will require MORE peso to service. Once again this adds to the cost side of firms exposed on USD borrowings that will amplify debt servicing onus that may reduce access to credit, thereby, put strains on profits and magnify credit risks.

Now here is how I saw the crashing ringgit’s impact on the Malaysian economy

YET it’s not just been about the ringgit’s collapse. There is also the issue of precipitous currency volatility. Combined, these dynamics have already been contributing to the already slowing economy.

But the linkages don’t stop there. There will be an economic-financial feedback mechanism where an economic downturn will lead to financial losses and vice versa. The epiphenomenon will be the shrinkage of systemic liquidity. The process of which will be spotlighted by the following feedback loop: the emergence of cash flow problems to debt servicing problems and to constrictions on access to credit. Finally, liquidity shrinkage will lead to insolvency, and concomitantly, to liquidations.

In short, a currency crash will likely be transmitted to as a banking or debt crisis.

Now real world economic anecdotes from Malaysia’s media The Star Online: (bold mine)

Many small and medium-sized enterprises (SMEs) in Malaysia are feeling the pinch of ringgit weakness, as it has led to an increase in cost pressures on their operations.

According to the SME Association of Malaysia, the decline in the value of ringgit vis-à-vis a rising US dollar has not only adversely affected the bottom lines of many companies, as raw material input costs increase, but the currency volatility has also resulted in cash flow problems for some.

“The ringgit’s depreciation has a negative impact on the production costs, cash flow and profits of most SMEs,” SME Association of Malaysia deputy president Michael Kang (pic)told StarBiz in an email.

He noted that many local SMEs had been grappling with higher production costs, as the bulk of their raw materials were imported. Exacerbating the pressure on their margins was the fact that most SMEs sell predominantly in the domestic market.

According to Kang, some SMEs were also facing difficulties in settling their payments to overseas suppliers due to the ringgit’s weakness.

“A majority of SMEs here do not actually have access to banking facilities such as loans and guarantees to meet their financing needs, so they depend on credit terms from their overseas suppliers,” Kang explained.

“But now, many have been badly hit because the ringgit has depreciated so much against the US dollar; some SMEs can’t even afford to settle their obligations to their suppliers and this may affect the future import of raw materials for their businesses,” he added.

Bullseye!

The crashing ringgit continues to tighten its stranglehold on the Malaysian economy.

The question is: up to what extent can the financial system keep up with this?

Yet all the propaganda peddled by Philippine media on the weak peso will eventually be met with economic reality.