Inflation is not caused by the actions of private citizens, but by the government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bank robbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments. —Ayn Rand
In this issue:
Q4 2022’s Historic Deficit Spending! Economic Freedom Rating Plunged Due to Fiscal Health, The Inflationary Financing of Deficits
I. Q4 2022’s Historic Deficit Spending! 2022 Annual Deficit was a Hair Breadth from 2021’s record!
II. Record Public Spending/Fiscal Deficit Reinforces Economic Centralization
III. Plunge in Economic Freedom Rating, Why Free Trade Pact (RCEP) is not Free Trade
IV. Escalating Concentration Risk as the BSP Embraces the Politicization of Financial Institutions via the Woke Model—ESG & Gender Equality
V. Financing of the Record Deficit Spending: Record Public Debt and Debt Servicing
VI. The Inflationary Financing of the Record Deficit Spending
Q4 2022’s Historic Deficit Spending! Economic Freedom Rating Plunged Due to Fiscal Health, The Inflationary Financing of Deficits
I. Q4 2022’s Historic Deficit Spending! 2022 Annual Deficit was a Hair Breadth from 2021’s record!
Inquirer.net, March 1: The Philippine national government’s budget deficit narrowed by 3.4 percent or P56 billion to P1.61 trillion in 2022 from P1.67 trillion in 2021, according to the Bureau of the Treasury. The deficit declined as an 18-percent surge in revenues (which reached P3.54 trillion) outpaced a 10-percent jump in expenses (P5.16 trillion).
Reports like this limn one side of a story. It projects an ambiance of optimism to its readers; that is, the outgrowth of tax collections translates to economic progress. All hail the government for the marvelous job!
But have aggregate public collections in 2022 truly exceeded the spending?
In a word, NO.
Figure 1
Though the cited % YoY numbers were accurate, the narrative egregiously omitted other statistical angles, such as the influence of the "base effects" and the month-on-month (MoM) picture.
For instance, seen from a % changes over the month, revenues plunged 19% in December, while expenditures soared by 42%.
The best viewpoint comes from the monthly peso trend. Here we see December 2022's Php 647 billion minting a new record, which topped the previous crown holder December 2021's Php 569.32 billion. So, in essence, the % YoY growth compared unprecedented feats, hence the "lower" growth rate! (Figure 1, topmost chart)
Amazing.
As further proof of the outperformance of spending, in peso, the budget deficit and spending of Q4 represented not only the LARGEST in history among the previous Q4s but also compared to ALL quarters! Nice huh? (Figure 1, middle and lower panes)
As % of the GDP, the Q4 2022 deficit of 9.3% represented the third biggest after the 11.5% of Q2 2022 and 9.4% of Q4 2021.
Annualized, 2022's deficit to (real) GDP accounted for 7.3%, which was lower than the 8.6% of 2021.
There's more.
The annual perspective provides the same story. It shows a similar contrast, highlighting the base effect and nominal growth.
That is, revenues outperformed in %, but in peso terms, spending ruled. And since public spending and deficits are accretive and programmed, while variable economic conditions drive revenues, the essence of the gaping fiscal deficit represents the dominance of public spending.
Yet, the mainstream seems blind to the two critical fundamental forces behind these deficits: the financing of such political extravagance (via public and private sector balance sheets) and its impact on prices, allocation, production, and labor or the economy.
The institutional echo chamber portrays political spending as an economic sine qua non. Worst, it is sold as a nostrum to the predicaments in almost every aspect of social activities.
Nevertheless, this represents a symptom of the evolution of people's mindset toward short-term orientation, shaped by an era of cheap money.
Inter alia, deficit spending can have only benefits. Long live free lunches!
II. Record Public Spending/Fiscal Deficit Reinforces Economic Centralization
And speaking of political extravagance, not only have authorities missed out on its CPI target, but worst, they exceeded their fiscal deficit goals too!
Businessworld, March 2: THE NATIONAL Government’s (NG) fiscal gap narrowed year on year to P1.61 trillion in 2022, but exceeded the budget deficit ceiling. Data from the Bureau of the Treasury (BTr) showed the full-year deficit was lower by 3.35% or P56 billion than the P1.67 trillion shortfall in 2021. It was also higher than the revised P1.502-trillion target set by the Development Budget Coordination Committee (DBCC) last December. “The fiscal outturn was driven by revenue growth of 17.97% outpacing the 10.35% expansion in government spending,” the BTr said in a press release on Wednesday. This brought the fiscal deficit to 7.33% of gross domestic product (GDP), lower than 8.6% in 2021 but higher than the DBCC target of 6.9%. (bold added)
Here is the thing.
The above depicts three interrelated forces: the process of economic centralization, the financing of deficit spending, and its contribution to the CPI.
Q4's incredible spending binge only reveals how the political domain has become so addicted to free money for them to ignore their targets.
This development reinforces the first factor, the thrust toward the centralization (neo-socialist model/fascism) of the economy.
Public spending to GDP, which in 2022 accounted for 23.43%, represents a follow-through of the record high of 24.1% in 2021. That is, the government has become a pivotal player in the GDP.
Yet, public spending represents only the direct spending activities of the government. The private sector has increasingly participated in political projects, which extrapolates to the understatement of resources and funds funneled to authorities.
It shows the diversion of more and more resources and financing to the government at the expense of the marketplace.
Government is not a wealth creator but a wealth consumer. The greater the resources consumed, the lesser are made available for productive use by the private sector.
Moreover, because government diverts resources from servicing consumers and redirects these toward targeted political constituencies, this fosters economic mismatches, affecting prices, production, coordination, and consumption.
Thus, the centralization of the economy, which alternatively implies reduced productivity from diminished economic freedom, leads to a lower standard of living. Instead, such an environment nurtures corruption, division, and inequality.
III. Plunge in Economic Freedom Rating, Why Free Trade Pact (RCEP) is not Free Trade
It should not be a surprise that the conservative institution, the Heritage Foundation, which devised the Economic Freedom Index, saw a significant withering of economic freedom in the Philippines.
Businessworld, March 3: THE PHILIPPINE ECONOMY is now considered “mostly unfree” as it dropped nine spots in the latest economic freedom ranking by US-based think tank The Heritage Foundation. In the 2023 Index of Economic Freedom report, the Philippines slumped to 89th out of 176 countries with a score of 59.3, 1.8 points lower than a year ago. Its economic freedom score is approximately the world average.
Figure 2
Worst, this decay hasn't been an anomaly—since peaking in 2017, economic freedom in the Philippines has been in a downtrend, as shown by the same chart I posted on my Twitter account. (Figure 2, upper chart)
The plunge in the economic freedom rating came from a sharp drop in government spending and fiscal health, as well as, declines in monetary freedom, property rights, and judicial effectiveness. (See, I am not alone)
In 2023, Philippine ratings fell under the taxonomy of "Mostly Unfree."
True, there are some areas where the government has attempted to liberalize.
For instance, last February, the Philippine government signed up for the Regional Comprehensive Economic Partnership (RCEP), supposedly a "free trade" pact with ASEAN nations and Australia, China, Japan, New Zealand, and South Korea.
But as Austrian Economist Thomas DiLorenzo remarked about free trade agreements,
Just because politicians call something a “free trade agreement” doesn’t make it one. They always choose wonderful-sounding names for their legislation, which in reality is usually the work of scores of greedy plunder-seeking lobbyists. (DiLorenzo, 2022)
In short, free trade doesn't require voluminous pages of what is allowed or not allowed, but simply laissez-faire. Are there statutory trade requirements for a resident of Makati City to buy in a San Juan City mall or from a Quezon City supplier?
Such a "free trade pact" liberalizes trade only for vested interest groups. As Cato Economist Dan Ikenson explained, (bold added)
Free trade is about removing impediments that benefit some at the expense of others so that each of us individually has the fullest battery of choices to decide how best to use our own resources. Free trade agreements are about managed trade and labyrinthine rules intended to distribute particular benefits to particular interests. (Ikenson, 2019)
And instead of bottom-up (decentralization), the mainstream favors a "trickle-down effect" perspective (centralization).
Businessworld, February 12: MICRO, small, and medium enterprises (MSMEs) can survive within an “ecosystem” making them part of a broader supply chain as larger companies take in more foreign direct investment (FDI), economists said. “The big fish can thrive with the small fish in a healthy ecosystem where they can exist symbiotically,” Ser Percival K. Peña-Reyes, director of the Ateneo Center for Economic Research and Development, said in a Viber message.
Again, it is no surprise that the centralization model of the political economy is popular.
IV. Escalating Concentration Risk as the BSP Embraces the Politicization of Financial Institutions via the Woke Model—ESG & Gender Equality
Of course, an increase in public spending represents an ingredient of the ongoing centralization process. But other unseen factors—such as the growing byzantine of taxes, mandates, regulations, and proscriptions through government/bureaucratic expansion—are also vital contributors to this process.
For example, there seems barely any appreciation by the public that authorities are on a slippery slope approach towards establishing a China-style social credit system.
First, authorities decreed a National ID system. Then, they are mandating "financial inclusion" through banks and financial institutions via a full adoption of the "national quick response (QR) code standard," which they expect to distill into the economy via payment transactions. The likelihood is that all transactions will someday be required to shift to digitalization—a war on cash—for social controls.
Later, to monitor the individual's activities in public places, authorities will likely implement an integrated nationwide system of biometrics and automated surveillance system.
That is, eventually, legal compliance and political status will determine an individual's access to financing.
This development underscores the centralization and politicization process of financial institutions. (Prudent Investor, 2022)
For example, hasn't the BSP been directing banks and financial institutions on how to allocate credit? Instead of the risk-reward tradeoff, the BSP now has a "Sustainable Central Banking" program to enforce "green and sustainable" policies in bank lending and investments.
It mandates financial institutions to pursue "strategic environmental and social objectives," which likely entails prioritizing funding of green investments as arbitrarily defined by them, such as renewable energy while restricting or limiting financing of industries or firms that heighten "climate and environmental risks," perhaps such as traditional (fossil fuel) energy.
From this view, the BSP is not only a central bank. Instead, the BSP has transformed into an environmental agency too. Fundamentally, it infringes on the role of the Department of Environment and Natural Resources (DENR). This dual or expanded role essentially politicizes credit and resource allocation to industries or institutions it sees fit—or as they unilaterally determine. (Political connections?)
And now, the BSP even advocates gender equality!
Businessworld, March 2: FINANCIAL institutions need to consider serving more female-owned micro-, small- and medium-sized enterprises (MSMEs), which are disadvantaged in accessing capital relative to male-owned businesses, the Bangko Sentral ng Pilipinas (BSP) said.
Astonishing!
Will the BSP establish "Gender Equality" Central Banking program too?
Yet, there is barely any public appreciation that its thrust to centralize the economy through the banking system ipso facto magnifies systemic risk!
As of December 2022, Universal and Commercial banks now command an eye-popping 78% of the nation's Total Financial Resources (FR) and 112% of FR/real GDP!! (Figure 2, lowest window)
Will this radical transformation to a "woke" central banking magically do away with the accelerating buildup of risks? Or will this intensify it?
V. Financing of the Record Deficit Spending: Record Public Debt and Debt Servicing
The Q4 public spending spree brings us to the second factor: The financing of the deficit.
Public debt represents the most conspicuous source of financing. The record deficit has also tagged along an unprecedented level of public debt. While public debt has reached Php 13.42 trillion or 60% of the GDP, debt servicing reached a record Php 1.3 trillion. (Figure 3, topmost chart)
One may argue that this debt is manageable. Yes, for the moment. Since debt servicing accounted for 36.5% of revenues in 2022, it remains slightly above the multi-year low reached in 2017 through 2019. (Figure 3, middle chart)
But here is the thing. Artificially lowered rates have substantially mitigated the onus of servicing debt. As such, it has encouraged the political domain to accelerate its economic paradigm anchored on borrow-and-spend.
And since authorities believe that the current predicament is "transitory," rising rates haven't dampened their appetite for spending. It won't. That is until forced by the markets.
Rising rates affect only the debt rollovers and the new offerings. It will have a negligible impact on the 75% share of the long-term maturity of the outstanding public debt. For now.
Yet, the longer higher rates remain, the greater the burden from increasing debt financing for refinancing and new offerings—which all depends on the changes in the scale of public spending relative to revenues.
Again, the cost of public spending is accretive while the revenues are variable, dependent on economic performance and administration efforts.
VI. The Inflationary Financing of the Record Deficit Spending
Aside from expanding control over political policies and finances, authorities have used deficit spending to bolster the GDP.
Public debt represents one of the many ways to finance such unprecedented deficit spending.
But authorities have become creative and bolder.
Figure 4
In tandem, the BSP and the financial institutions have partaken roles in the funding government. Both have been engaged in unparalleled lending to finance the unrivaled deficit spending. A parallel objective is to use Treasuries as collateral to infuse liquidity into the financial system.
That said, deficit spending influences prices in the economy. The impact of deficits on the CPI represents our third factor.
If financed solely by taxes, deficit spending won't be inflationary. But when financed by money creation through banks and the BSP, known as debt monetization, deficit spending is inflationary.
Net claims on the Central Government of banks and the BSP continue to etch milestone highs. (Figure 4, upper window)
This buildup on Net claims has resonated with the Held-to-Maturity (HTM) holdings of the banking system. An update on the financial conditions of banks is due next week.
And it has been of little surprise to us why the BSP dumped liquidity via the release of deposits last December. (Prudent Investor, 2023)
The biggest monthly spending required enormous amounts of liquidity! The economy has yet to account for the impact of this massive liquidity dump to finance the record deficit spending last December.
But the relationship between deficit spending and the CPI is too egregious to ignore.
The follow-through record high of the expenditure to GDP in 2022 has coincided with the breakout of the CPI. Another angle is the quarterly performance of the deficit and the CPI, which provides a close-up picture of its relationship. (Figure 4, middle and lower windows)
Yet it is jarring to see why the mainstream keeps a lid on this.
After a historic Php 2.3 trillion liquidity injection in 2020-21, did they not expect any impact on prices, spending, and production?
Did they not expect that money supply expansion to finance national elections would have also an impact on the CPI?
Were they not cheering the substantial boost in bank lending, which they sold to the public as "growth?" How would this not impact the prices and the economy?
The BSP and banks print oodles of money and expect free lunches? Amazing!
For instance, in a recent speech, the BSP Governor expounded on the "supply side" aspects of inflation, "Much of these is because of supply shocks."
But on the demand side, he explained:
At any rate, my point is that we have taken all the necessary policies on the demand side. We have taken all the necessary policies on the exchange rate side. We have taken all the necessary policies on the interest side and are willing to take some more, if necessary. (Medalla, 2023)
Without explaining how and why these measures were undertaken and their expected impact, he switched back to discussing the possible influence of external factors on supply!
Incredible.
We can only suspect that the fundamental reason for such denial comes from the intent to protect the enshrined economic model of deficit spending!
After all, the government benefited immensely from inflation, directly through collections and indirectly through the inflation tax.
Changes in BIR revenues have dovetailed with the CPI. (Figure 5, upper chart)
Finally, everyone seems to believe that the impact of rising rates on the economy will be limited.
Given the financial backdrop where either public debt or bank credit drives the economy—now both are the drivers(!)—the ramifications of rising rates will be intertemporal—having distinctive effects on specific entities in different periods. (Figure 5, lower chart)
With total formal credit at 109% of the GDP, the repercussions from the rate hikes should be interesting.
My humble guess is that its ramification will confound almost everyone!
___
References
DiLorenzo, Thomas J. Politically Incorrect Guide to Economics, Regnery Publishing, August 2022
Ikenson, Daniel J.; Protectionist Love Child of the Labor Left and the Nationalist Right, Cato at Liberty, Cato Institute December 13, 2019
Prudent Investor, The Centralization of the Philippine Banking System Magnifies Concentration and Contagion Risks, January 23, 2023 Substack, Blogger
Prudent Investor, The BSP Unveils Stealth QE 2.0 (Variant)! January 15, 2023 Substack, Blogger
Medalla Felipe M: Supporting the continued growth of the fund management industry, speech at the fund Managers Association of the Philippines (FMAP) General Membership Meeting and Induction of Officers, Manila, 20 February 2023. Bank for International Settlements bis.org
