Philippine Politics: To Save the Kids, Stop Inflationism, Promote Economic Freedom; Henry Hazlitt’s Cure for Poverty

In the Philippines, election season is upon us or just about a year and a few months away, so populist politics has once again been hugging the headlines. 

So what easier way to boost popular approval to generate future votes than—not only to focus on “poverty”—but to publicly appeal for compassion by fixating on a specific group: poverty on kids. 

Yet most of the proposed solution has been the same since time immemorial; more centralization, bigger government or simply more redistribution: multiplying wealth by dividing it.

So for this election season, it seems that poor kids will serve as instruments of sloganeering for the advancement of political careers of politicians.

Politicians make it sound is as if the private sector has no sense of compassion at all. Hardly the politicians realize that from an economic standpoint, the relief of poverty equates to the well-being of enterprises.

Charity requires no political mandates. 

So why shouldn’t the private sector contribute voluntarily? There are numerous civic groups (such as Rotary, Lions and et.al.) working to help solve social ills by voluntarism. [The two Rotary's which I used to be a member of have active feeding programs mainly on public schools]

The question is what has been an obstacle to private sector solutions?

There has been almost zero zilch nada nein nyet in any mainstream discussion has tackled on how financial repression or government redistribution policies mainly through central bank inflationism has served as a fundamental and structural reason in raising self-poverty ratings that has spurred populist calls for more centralized solution on poverty. 

Add to this the plethora of interventionisms via mandates, regulations, government spending and more all finance by higher taxes. Where will taxes come from? Manna from heaven?

Yet hasn’t it been contradictory to see a swelling of self poverty ratings in the face of G-R-O-W-T-H?

The clueless mainstream calls 'strong' economic growth and soaring self poverty ratings a “paradox”. They apparently have been long blind to comprehend that statistical G-R-O-W-T-H has been occurring to a few ‘concentrated’ bubble sectors, controlled by mostly the elites, whose G-R-O-W-T-H (use of more resources) has occurred from extensive leveraging in the formal banking system and capital markets—coming at the expense of or, all financed by Peso holders (via the use of less resources but pays the cost of higher prices or diminished purchasing power on income or savings).

Yet the same politically connected or influential economic elites contributes to a significant majority to the statistical economic output which mainstream G-R-O-W-T-H which is the reason for the “strong”. 

But statistical growth isn’t real economic growth. That's what the "paradox" has been about.

It is only when this massive redistribution mechanism via invisible subsidies in favor of the government and to these political elites channeled through the banking system diminishes when the burdens of self-poverty eases (as I have previously shown in SWS’s chart last August)

I post below the great libertarian Henry Hazlitt’s proposal for the cure for poverty.  From the Conquest of Poverty (chapter 20: The Cure of Poverty p 229-234; bold and italics mine)

Individual or family poverty results when the "breadwinner" cannot in fact win bread; when he cannot or does not produce enough to support his family or even himself. And there will always be some human beings who will temporarily or permanently lack the ability to provide even for their own self-support. Such is the condition of all of us as young children, of many of us when we fall ill, and of most of us in extreme old age. And such is the permanent condition of some who have been struck by misfortune—the blind, the crippled, the feebleminded. 

Where there are so many causes there can be no all embracing cure. 

It is fashionable to say today that "society" must solve the problem of poverty. But basically each individual—or at least each family—must solve its own problem of poverty. The overwhelming majority of families must produce more than enough for their own support if there is to be any surplus available for the remaining families that cannot or do not provide enough for their own support. Where the majority of families do not provide enough for their own support—where society as a whole does not provide enough for its own support—no "adequate relief system" is even temporarily possible. Hence "society" cannot solve the problem of poverty until the overwhelming majority of families have already solved (and in fact slightly more than solved) the problem of their own poverty.

All this is merely stating in another form the Paradox of Relief referred to in Chapter 18: The richer the community, the less the need for relief, but the more it is able to provide; the poorer the community, the greater the need for relief, but the less it is able to provide. 

And this in turn is merely another way of pointing out that relief, or redistribution of income, voluntary or coerced, is never the true solution of poverty, but at best a makeshift, which may mask the disease and mitigate the pain, but provides no basic cure.

Moreover, government relief tends to prolong and intensify the very disease it seeks to cure. Such relief tends constantly to get out of hand. And even when it is kept within reasonable bounds it tends to reduce the incentives to work and to save both of those who receive it and of those who are forced to pay it. It may be said, in fact, that practically every measure that governments take with the ostensible object of "helping the poor" has the long-run effect of doing the opposite. Economists have again and again been forced to point out that nearly every popular remedy for poverty merely aggravates the problem. I have analyzed in these pages such false remedies as the guaranteed income, the negative income tax, minimum-wage laws, laws to increase the power of the labor unions, opposition to labor-saving machinery, promotion of "spread-the-work" schemes, special subsidies, increased government spending, increased taxation, steeply graduated income taxes, punitive taxes on capital gains, inheritances, and corporations, and outright socialism.

But the possible number of false remedies for poverty is infinite.

Two central fallacies are common to practically all of them. One is that of looking only at the immediate effect of any proposed reform on a selected group of intended beneficiaries and of overlooking the longer and secondary effect of the reform not only on the intended beneficiaries but on everybody.

The other fallacy, akin to this, is to assume that production consists of a fixed amount of goods and services, produced by a fixed amount and quality of capital providing a fixed number of "jobs." This fixed production, it is assumed, goes on more or less automatically, influenced negligibly if at all by the incentives or lack of incentives of specific producers, workers, or consumers. "The problem of production has been solved," we keep hearing, and all that is needed is a fairer "distribution."

What is disheartening about all this is that the popular ideology on all these matters shows no advance—and if anything even a retrogression—compared with what it was more than a hundred years ago. In the middle of the nineteenth century the English economist Nassau Senior was writing in his journal:

"It requires a long train of reasoning to show that the capital on which the miracles of civilization depend is the slow and painful creation of the economy and enterprise of the few, and of the industry of the many, and is destroyed, or driven away, or prevented from arising, by any causes which diminish or render insecure the profits of the capitalist, or deaden the activity of the laborer; and that the State, by relieving idleness, improvidence, or misconduct from the punishment, and depriving abstinence and foresight of the reward, which have been provided for them by nature, may indeed destroy wealth, but most certainly will aggravate poverty."

Man throughout history has been searching for the cure for poverty, and all that time the cure has been before his eyes.

Fortunately, as far at least as it applied to their actions as individuals, the majority of men instinctively recognized it—which was why they survived. That individual cure was Work and Saving. In terms of social organization, there evolved spontaneously from this, as a result of no one's conscious planning, a system of division of labor, freedom of exchange, and economic cooperation, the outlines of which hardly became apparent to our forebears until two centuries ago. That system is now known either as Free Enterprise or as Capitalism, according as men wish to honor or disparage it.

It is this system that has lifted mankind out of mass poverty.

It is this system that in the last century, in the last generation, even in the last decade, has acceleratively been changing the face of the world, and has provided the masses of mankind with amenities that even kings did not possess or imagine a few generations ago.

Because of individual misfortune and individual weaknesses, there will always be some individual poverty and even "pockets" of poverty. But in the more prosperous Western countries today, capitalism has already reduced these to a merely residual problem, which will become increasingly easy to manage, and of constantly diminishing importance, if society continues to abide in the main by capitalist principles. Capitalism in the advanced countries has already, it bears repeating, conquered mass poverty, as that was known throughout human history and almost everywhere, until a change began to be noticeable sometime about the middle of the eighteenth century. 

Capitalism will continue to eliminate mass poverty in more and more places and to an increasingly marked extent if it is merely permitted to do so.

In the chapter "Why Socialism Doesn't Work," I explained by contrast how capitalism performs its miracles. It turns out the tens of thousands of diverse commodities and services in the proportions in which they are socially most wanted, and it solves this incredibly complex problem through the institutions of private property, the free market, and the existence of money—through the interrelations of supply and demand, costs and prices, profits and losses. And, of course, through the force of competition. Competition will tend constantly to bring about the most economical and efficient method of production possible with existing technology—and then it will start devising a still more efficient technology. It will reduce the cost of existing production, it will improve products, it will invent or discover wholly new products, as individual producers try to think what product consumers would buy if it existed. 

Those who are least successful in this competition will lose their original capital and be forced out of the field; those who are most successful will acquire through profits more capital to increase their production still further. So capitalist production tends constantly to be drawn into the hands of those who have shown that they can best meet the wants of the consumers.

Perhaps the most frequent complaint about capitalism is that it distributes its rewards "unequally." But this really describes one of the system's chief virtues. Though mere luck always plays a role with each of us, the increasing tendency under capitalism is that penalties are imposed roughly in proportion to error and neglect and rewards granted roughly in proportion to effort, ability, and foresight. It is precisely this system of graduated rewards and penalties, in which each tends to receive in proportion to the market value he helps to produce, that incites each of us constantly to put forth his greatest effort to maximize the value of his own production and thus (whether intentionally or not) help to maximize that of the whole community.

If capitalism worked as the socialists think an economic system ought to work, and provided a constant equality of living conditions for all, regardless of whether a man was able or not, resourceful or not, diligent or not, thrifty or not, if capitalism put no premium on resourcefulness and effort and no penalty on idleness or vice, it would produce only an equality of destitution.

Another incidental effect of the inequality of incomes inseparable from a market economy has been to increase the funds devoted to saving and investment much beyond what they would have been if the same total social income had been spread evenly. The enormous and accelerative economic progress in the last century and a half was made possible by the investment of the rich—first in the railroads, and then in scores of heavy industries requiring large amounts of capital. The inequality of incomes, however much some of us may deplore it on other grounds, has led to a much faster increase in the total output and wealth of all than would otherwise have taken place.

Those who truly want to help the poor will not spend their days in organizing protest marches or relief riots, or even in repeated protestations of sympathy. Nor will their charity consist merely in giving money to the poor to be spent for immediate consumption needs. Rather will they themselves live modestly in relation to their income, save, and constantly invest their savings in sound existing or new enterprises, so creating abundance for all, and incidentally creating not only more jobs but better-paying ones. 

The irony is that the very miracles brought about in our age by the capitalist system have given rise to expectations that keep running ahead even of the accelerating progress, and so have led to an incredibly shortsighted impatience that threatens to destroy the very system that has made the expectations possible.

If that destruction is to be prevented, education in the true causes of economic improvement must be intensified beyond anything yet attempted.

The cure for poverty is for the government to STOP COERCIVE REDISTRIBUTION via financial and economic repression. The obverse side is to PROMOTE SOUND MONEY and ECONOMIC FREEDOM. But none of this economic reality will generate votes.

Phisix: BSP’s Response to Peso Meltdown: Raise Banking Reserve Requirements

Keynesianism has the markings of a religion. It has a confession: "Fiat money overcomes recessions." It has an agenda: salvation by economic growth. It has a doctrine of omniscience: monetary central planning. It has a priesthood: Ph.D-holding economists. It has evangelism: Congress, the universities, and the mainstream media.—Gary North

In this issue:

Phisix: BSP’s Response to Peso Meltdown: Raise Banking Reserve Requirements

-Economic Repression Equals Smuggling and the Informal Economy

-The Real Score Behind Philippine Peso and Balance of Payment

-Philippine Bonds Dissatisfied with BSP’s Actions

-Media Cheers as the BSP Tweaks Reserve Ratio

-Assailing the Informal Economy: The Philippines Bans Coin Savings

-Rotation or Risk ON or Bull Trap???

Phisix: BSP’s Response to Peso Meltdown: Raise Banking Reserve Requirements

The Philippine Peso, which closed at 44.88 against the US dollar in the week ending March 28^th, shaved off two thirds of the significant 1.43% loss accrued from last week’s meltdown. The rally in the peso came in tandem with a marginal rebound in Philippine 10 year bonds where yields slipped by 10 bps to 4.471% as the Phisix eked out a .32% gain.

Although this week’s rally somewhat resonated a “Risk On” environment, behind all these appears to be the substantial interventions by the Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) which culminated with Thursday’s raising of reserve requirements on the banking system[1] or what the mainstream labels as “tightening”.

Such action confirms on my narratives of the domestic risk environment where “today’s operating environment has been vastly different from the heydays of 2013. Then the Phisix boom has been in confluence with zero bound rates, low statistical consumer price inflation figures and a firming Peso. In essence, the Phisix sailed in the tailwind of a Risk ON easy money landscape. Today, tailwind has morphed into headwind—falling peso, rising yields and even higher statistical price inflation. Yet stock market punters have been desperately forcing to reinstate or resurrect the past.”[2]

Economic Repression Equals Smuggling and the Informal Economy

I watched in engaging curiosity how the mainstream has desperately been scurrying to explain on the unexpected sluggishness of the peso which has gone beyond the entrenched popular perception of the supposed insuperability of the Philippine economy.

One interesting view has been to raise “smuggling” as the culprit of the peso’s predicament.

Highly paid experts from foreign institutions suggests that “import data may have been understated since as early as 2007”, partly because of smuggling which has undermined the strength of the nation’s current-account surplus and the peso[3].

The wonderful part of this explanation is that this appears to validate my long held tenet that the Philippine government statistics vastly suffers from the “skewedness or specifically the non-representativeness of statistical growth data relative to real economic conditions”[4]

But “smuggling” for me serves as a convenient scapegoat/bogeyman for the peso’s travails.

What is smuggling? Smuggling according to Wikipedia is the illegal transportation of objects or people…in violation of applicable laws or other regulations.

As a side note: in this discussion I will be dealing with smuggling of goods.

The basic reason why smuggling exists is that there is extant demand for goods that has been proscribed or regulated by political authorities. However despite the legal barriers, because of the profit motive to service such demand, entities have worked to circumvent on such mandates via legal or accounting loopholes or bribery or through other avenues.

Put differently, “smuggling” represents the unintended consequence of economic and financial repression that constitutes part of the informal economy[5].

Goods smuggling can be inbound or outbound.

Two examples. 

Outbound Smuggling. In 2012, when the BSP raised gold sales tax to 7%—consisting of a 2-percent excise tax and a 5-percent creditable withholding tax, perhaps under the prodding of the IMF[6]—the consequence has been a 90% devastating collapse[7] in the sales of the small scale miners to the legal sole buyer the BSP. The small scale miners, whose production constitutes about 56% of the nation’s gold output have mostly gone underground. The more than doubling of the tax rates has apparently exceeded the tolerance level of small miners and thus has provoked them to use the “tax free” outbound or export route called “smuggling”.

Simplistic expectations to raise revenues by increasing taxes boomeranged. Through economic-financial repression of raising tax rate levels, the Philippine government incentivized small scale mining to shift into smuggling.

This King Canute effect has even been more pronounced in India, where the Indian government has vastly reduced the Indian gold trading in both domestic and the international sphere. The ramification has been to almost entirely divert the gold industry underground. Gold seized from smuggling “multiplied by 14 times between FY ’11 and FY ’14”.[8]

Inbound smuggling. Sin taxes serves as another splendid example of government induced inbound “smuggling”.

In the name of curtailing vices but really to raise revenues for the insatiable spendthrift government, the Philippine government raised taxes on cigarettes and alcohol in 2012. However in contrast to political mainstream’s expectations, the consequence has been the same—the King Canute effect—a collapse in tax revenues and massive substitution in commercial activities through “smuggling”[9].

This King Canute effect of sin taxes has also been the same in the US where higher taxes continues to prompt for unbridled smuggling[10]. 

The King Canute effect simply reveals that legal edicts, mandates or regulations cannot and will not subvert the fundamental laws of economics.

Generally, inbound “smuggling” adds provision of supply to the economy. This should lower prices and give consumers more choice, which in essence, enhances the consumer’s purchasing power and satisfaction.

Yet the only entities harmed by inbound “smuggling” have been the resource starved extravagant government and their constituents—welfare, warfare, bureaucracy and Pork Barrel based politicians—and their select private sector allies: inefficient companies protected by anti-competition legislations.

And in the name of saving jobs, instituting economic repression via protectionism and financial repression promotes joblessness by restricting investments and thus commercial activities. Ever wonder why despite the so-called “boom”, joblessness remains chronic?

In addition, economic repression protects the financial and economic interests of the entrenched politically connected few. Residents of the Philippines are all consumers—all 96.7 million. Thus, economic repression is tantamount to sacrificing the interests of 90+ million consumers for the benefit of a few tens of thousands. Yet this is what populist politics—social democracy—is made of.

As one would notice, the government creates their self-made “Frankenstein-s”, which ironically they publicly declare are subject for extermination. How? By doing exactly the same things that has engendered their existence.

Nonetheless the so-called proliferation of smuggling activities magnifies on the government statistical inaccuracies.

And importantly, government action to contain smuggling embodies her sustained assault on the informal economy. So how can restraining economic activities via repression extrapolate to economic growth??? Beats me, but this is how popular logic flows.

The Real Score Behind Philippine Peso and Balance of Payment

And why should “smuggling” extrapolate to a weak peso?

The popular argument indicates that “smuggling” enervates the Philippine financial standings via the trade and current account “deficit” channel. This is partly true but hardly provides a sufficient explanation for the rest.

Based on the accounting identity called Balance of Payments (BOP) which “record of all monetary transactions between a country and the rest of the world” the total has to be ZERO

According to Wikipedia.org[11] “When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.”

The accounting identity[12]:

BOP = CURRENT ACCOUNT + CAPITAL ACCOUNT = CREDITS - DEBITS= 0

In and of itself, this means that deficits are hardly the cause of a currency’s travails, if they are sufficiently funded.

Deficits become a source of concern when the deficit nation’s funding has been perceived as increasingly becoming inadequate or deficient and or when creditors’ confidence are shaken due to an observed deterioration in the nation’s capacity or the ability or the willingness to pay on her liabilities. 

Wikipedia.org describes the balance of payment crisis or a currency crisis[13]:

A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency.

So the agonizing peso has hardly been about “deficits” per se but rather about the 38.6% M3 growth last January which according to the BSP has been “due to higher demand for credit[14]”. 

Yet it has been simply amazing at how the mainstream experts see money and debt as operating in a black hole when discussing exchange rate values.

But this shouldn’t be the case since even celebrity guru Nouriel Roubini, in his lectures in Macroeconomics at the New York Sterns University, has been aware that exchange rates are basically determined by the quantity theory of money as part of the “classical theory of exchange rates” that also includes Purchasing Power Parity.

In the lecture Dr. Roubini cites that a “currency weakens…if we issue more money than the other country”, although the effect is “considerably better over longer periods” than over the short term.[15]

In short even from the mainstream perspective money supply should play a big role in ascertaining of exchange rate ratios.

And as I have long been explaining, it is the demand and supply for a currency unit that determines the exchange rate values. To quote again the late great Austrian economist Ludwig von Mises “the valuation of the monetary unit depends not upon the wealth of the country, but upon the ratio between the quantity of money and the demand for it, so that even the richest country may have a bad currency and the poorest country a good one.[16]”

Such demand and supply for a currency unit will thus be ventilated on the conditions of Balance of Payment. How? Through profit margins as determined by price levels. Again Professor von Mises[17] (bold mine)

The balance-of-payments theory forgets that the volume of foreign trade is completely dependent upon prices; that neither exportation nor importation can occur if there are no differences in prices to make trade profitable. The theory clings to the superficial aspects of the phenomena it deals with. It cannot be doubted that if we simply look at the daily or hourly fluctuations on the exchanges we shall only be able to discover that the state of the balance of payments at any moment does determine the supply and the demand in the foreign-exchange market. But this is a mere beginning of a proper investigation into the determinants of the rate of exchange. The next question is, What determines the state of the balance of payments at any moment? And there is no other possible answer to this than that it is the price level and the purchases and sales induced by the price margins that determine the balance of payments. Foreign commodities can be imported, at a time when the rate of exchange is rising, only if they are able to find purchasers despite their high prices.

Changes in the quantity of money have been intertwined with changes in relative price levels of goods and services in the economy that gets to be reflected on both Balance of Payment and currency values.

In the Philippine context, the twin siblings of credit financed asset bubbles and price inflation have been working their way towards reconfiguring the Balance of Payment (BOP) standings.

Relative price inflation pressures, which have been indicative of a maturing credit fuelled property bubble, have begun to manifest itself via government statistics. Rising inflation has now percolated into the bond and currency markets via market prices, in particular higher yield and the declining peso. Despite last week’s improvements, mostly from BSP interventions, the bond and especially the peso remain far from its original ‘easy money’ disposition. Economic logic tells us that such rally cannot be sustained overtime.

As a side note, part of the rally by the peso this week has been due to the "risk ON" regional influences.

And as pointed out last week, Philippine trade balance has been worsening during the current inflationary boom. This means that the falling peso will function as a secondary force or an aggravating factor to the overheating credit financed property, property related and stock market bubbles. A feedback loop mechanism between domestic inflationary forces with the falling peso has been progressively intensifying.

Inbound smuggling has most likely played a big role in the bridging supply provisions for the bubble sector as well as for the general economy, thus has cushioned price inflation during the nascent boom. But this is about to change too.

The falling peso may serve to naturally reduce inbound smuggling not because of policy enforcement but because of reactions to price changes. Moreover, the government’s publicly declared onslaught against smuggling will add to supply side pressures thus exacerbating domestic inflationary pressures. [As an aside, my barber just increased haircut fees by 25%].

In their latest disclosure to increase reserve requirements the BSP appear to be confirming my stagflationary projection[18]:

At the same time, the Monetary Board noted that the balance of risks to the inflation outlook continues to be skewed to the upside, with potential price pressures emanating from pending petitions for adjustments in utility rates and from the possible increases in food and oil prices.

Think about unintended consequences from the zany collision of policies from the incumbent government: the BSP wants to contain price inflation but the unleashing of spending power from banking credit finance in the face of restricting supply via combating “smuggling” by the executive department will likely mean both of them will be proven wrong or none of the two objectives (containment of inflation and prevention of smuggling) will succeed.

And given the apparent structural shift in the economic framework—specifically from external trade to internal asset bubbles—the falling peso will hardly benefit exporters. That’s because much of the resources have already been committed or sunk into bubble projects that will eventually be exposed as unviable via financial losses. In addition domestic inflation will negate any marginal advantages brought by the “cheaper” peso. And this has been fantastically evident in the peso’s long term trend. Despite the 95++% decline of the peso against the US dollar over 55 years, financial and economic repression have hardly brought about advantages to external trade.

Worse, should a real tightening occur, exporters will likely be affected by credit rationing. And the tanking peso will likely upset importers where much of them have also been tied to providing supplies to the bubble sector as explained last week.

Additionally, the greater demand for credit, which again will be reflected on money supply growth, will also be vented on interest rates and on the peso.

So this means that for as long as the BSP permits the inflation of credit fueled asset bubbles, surging price levels compounded by deteriorating or massive expansion of debt conditions will persist to manifest on a corrosion of the much vaunted external conditions of the Philippine economy that will be expressed on interest rates and on the peso.

Stock exchange participants will be the last to know.

A very clear example of this price level-BOP change can be seen via foreign exchange reserves. Again as I pointed out last week, concomitant to the surge in the USD-peso to August 2010 levels late January, the Philippines’ forex reserves tumbled by 5.7% also in January. [note: Philippine forex reserves gained 1.8% in February]

The implication is that the BSP has opted to forego the use of the interest rate channel and instead elected to defend the peso by intervening in the currency markets with the use of the surplus US dollars to buy up the peso. The Philippine government has been so deeply addicted to the stimulus provided by negative real rates (financial repression) such that the BSP can hardly backtrack from implementing bubble blowing policies. Thus the use of reserve requirements rather than the interest rate policy.

Aside from the raising the reserve requirements ratio, given the wild intraday movements of the peso during the week, I deeply suspect that the BSP may have used anew forex reserves to defend the peso. We will see the March data in about two months.

While “smuggling” may have inconsequentially contributed to the pesos’ predicament, the ultimate driver has been the relative money supply growth brought about by a runaway credit bubble that has been influencing price level changes in the economy, the currency and the BOP profile.

Such dynamics is something the mainstream seems to have lost touch with.

Philippine Bonds Dissatisfied with BSP’s Actions

Early last week even foreign media has noticed that as the peso plummeted, hikes in the yield curves in Philippine bonds have expressed alleged “speculations on interest rate tightening”[19].

The weekly rally in the 10 year domestic bonds came first with an initial loss where the 10 year yield spiked to 4.625% before backing off to 4.471%.

Yields of 20 year bonds also expanded to 5.584% before retracing to 5.519% at the week’s close. Although 20 year yields have remained up compared to last week’s close at 5.472%. The same story can be told of the 5 year treasuries where yields charged to 3.862% before withdrawing to 3.748%. From last Friday’s 3.606%, this Friday’s yield decline has not been enough to expunge on the earlier losses.

The interesting picture comes with the short term treasuries. Yields of the 6-month, 1 year and specially the 2 year treasuries have been pushed significantly higher and stayed up until the week’s close.

The BSP actions have hardly influenced the elevated yields of 6 month and 1 year treasuries (now nearly at July 2013 highs) and has instead spiked yields of 2 year treasuries driving the latter’s yields back nearly to January highs.

Given that short term yields have increased faster than the longer end, Philippine yield curve seems as materially flattening.

Higher yields on the short end are symptoms of liquidity strains. While this may be temporary it surely represents signs of ongoing dislocations.

Yet a flattening of the slope as I wrote in April 2013[20] will theoretically reduce the banking system’s net interest margins. Although today’s banking system has been more sophisticated since they don’t rely on net interest income alone…the banking system will have to rely on non-loan markets, otherwise there will be pressure on profits.

So while the peso rallied in the back of BSP’s actions, we seem to be seeing growing signs of fractures in the Philippine treasury market which ironically has been tightly controlled by the banking system and the government.

Who among the banks-financial institutions have been feeling the heat?

Media Cheers as the BSP Tweaks Reserve Ratio

Aside from the other week’s steep plunge of the peso and this week’s seizures in the domestic treasury markets, the BSP previously issued reports covering domestic liquidity and banking loan of the previous month during the end of each month, see the links to the BSP archives of February and January. So I expect the same reports by next week.

Could it be that the Philippine currency and the Philippine treasury markets have both been anticipating another 30++% M3 growth??? Has the BSP’s response also been in reaction to the coming report?

Regardless, the BSP’s move to raise the reserve requirement ratio from 18 to 19% of deposits effective April 4, 2014 represents a symbolic drop in the bucket.

This only means a 5% decrease in the banking system’s potential to expand credit creation. In 2013 banking loans grew by 16.4% or a total of Php 567.7 billion. Should 2014 experience the same nominal rate of growth then this would only mean a reduction of a mere Php 28 billion pesos.

Nonetheless given that the announced capex by real estate and real estate related sectors at conservatively Php 250 billion where most of these will be financed by loans (although reportedly favoring the bond markets), if financed by banking system this will easily surpass the 2013 threshold.

The above diagrams from the BSP’s 2013 annual report[21] represent a stunning picture of the fractional reserve banking at work. Deposits in the Philippine banking system zoomed by a whopping 36% year on year! Deposit growth has practically mirrored the growth in money supply (right).

In the world of fractional banking system, banks issue loans (money from thin air), borrowers spend the money on goods and services while sellers of goods and services deposit sales proceeds to the banking system. Meanwhile reserve requirements are banking mandates to service depositor withdrawals.

As the Mises Institutes wiki explains[22]

The practice of fractional reserve banking expands credit and therefore also expands the money supply (demand deposits and cash) beyond what it would otherwise be in a stable money system. Due to the prevalence of fractional reserve banking, the broad money supply (deposits created via the issuance of loans plus cash) is a much larger multiple than the amount of "real" paper currency created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators, and by the excess reserves kept by commercial banks.

If we apply this say in the US where reserve rate is at 10% (or 1/10%), and say $10,000,000 in new reserves, the maximum amount of credit expansion from $10m in new reserves is $100 million[23]

Back to the BSP, the new deposit requirement (based on December 2013 deposits of Php 6,059.7 billion) at Php 1.151 trillion already reflects 19% of the BSP’s January’s M3 data. Special Deposit Accounts (SDA) fell by 16.6% over the same period or Php 273 billion had been reverted back to the banking system deposits. Yet it is unclear to me how deposit growth of a staggering Php 1.610 trillion or signifying 2.25x the banking system’s general loan growth has been accomplished.

I suspect that part of such deposit growth may have emanated from offshore banking foreign currency based borrowing that had been converted into pesos which had been spent and deposited into the domestic banking system.

Yet the marginal tweaking by the BSP seems have been seen as unsatisfactory by the domestic bond markets. Ironically some in the mainstream have read this as “tightening” while other experts even alleged that this would be a guide to lower inflation. M3 growth at 30+++ leads to lower inflation??? Water flows uphill now?

Nonetheless, the BSP’s use of the reserve requirements rather than the interest rate policy appears to validate my claim last week that the “BSP has been BOXED into a corner”.

Since the Philippine government has become so deeply addicted to the free lunch provided by monetary steroids or to invisible subsidies in favor of the government and government pet bubble industries that has been charged at the expense of the lowly currency holder, thus the BSP will kick real tightening down the road.

This week’s superficial actions by the BSP in response to the domestic bond and currency market turmoil appear to be a showcase of such pretend-and-extend policies, and thus the variable market responses.

Yet it seems that ultimately it would take a violent market upheaval to force the hands of the BSP.

What will be the outcome of the conflicting policies between the executive branch and the BSP? How much more market turbulence can the BSP afford to pacify? At what costs?

Convulsing Philippine peso and treasury markets have hardly been signs of the return of a bullish ‘easy money’ backdrop. To the contrary these are indications of tightening conditions. Most importantly, they serve as the proverbial writing on the wall.

Assailing the Informal Economy: The Philippines Bans Coin Savings

There are two metrics to gauge whether a nation is on path to attain real economic growth. One is economic freedom (pillared by personal choice, voluntary exchange coordinated by markets, freedom to enter and compete in markets, and protection of persons and their property from aggression by others[24]).

The other is sound money policies[25] founded in “the market's choice of a commonly used medium of exchange” and is “negative in obstructing the government's propensity to meddle with the currency system”.

It is bad enough for a government to penalize their constituents by indirectly promoting transfers of resources to political agents and their favored allies via inflationism or bubble blowing policies. But it is even worse when political forces mount a direct assault on people’s savings and property rights.

Reports say that House Bill 1662 the criminalization of coin hoarding was recently passed in the House panel. The bill supposedly aims[26] to “discouraging private hoarding of coins and by encouraging the people to deposit their money in banking institutions”. It also aims to “re-circulate the hoarded Philippine legal tender coins collected and kept by syndicates currently hoarding coins with impunity that are smelted and converted into another materials of various industrial uses”

First the government monopolizes the money issuance, then restricts the people’s choice of the medium to save. Worse, a mistake in the choice of savings may lead to incarceration and heavy fines. One’s money and savings are now subject to outright confiscation, if not harassment via repressive legislations that openly promotes the interests of the banking industry.

Remember there are only 2 out of 10 households who have access to the banking system, this means many in the informal economy save by virtue of accumulation of coins and in paper money. So essentially this coin hoarding bill signifies as a direct assault on the informal economy. This will also be an attack on the innocent.

Instead of democratizing economic opportunities to encourage the informal sector to grow and assimilate into the formal economy, the incumbent government has been waging war at almost all fronts against the informal economy who mostly represent the middle class or the underprivileged.

First of all coin shortages are often symptoms of inflationism as expressed via the Gresham’s law[27]—“When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation”

Recent accounts of coin shortages have been seen in Sri Lanka (2007 and 2014) and in Argentina where 524 million coins issued in 2008 simply vanished[28].

In Zimbabwe, people who saved in coins survived former governor of Zimbabwe’s central bank Gideon Gono’s hideous hyperinflation which peaked at 89,700,000,000,000,000,000,000% in November 2008.

From the Wikipedia.org[29] (bold mine)

All old coins dating from the first dollar were reintroduced at face value to the third dollar in Aug 2008, effectively increasing their value 10 trillion-fold, and new $10 and $25 coins were introduced.

And recent accounts of coin shortages in Zimbabwe appears to have been eased by market based mobile banking system[30]

As I pointed out far back in May 2012[31], the Philippine government finally admits that “intrinsic value of the coin is greater than its nominal value especially for the lower-denominated coins” which means the government has been inflating the purchasing power of the local currency, the paper Peso, away.

So by prohibiting or restricting coin savings, the Philippine government essentially limits individual protection from government’s destruction of the currency.

Next coin shortages have been an age old problem.

In medieval Europe when metal prices were lower than the face value of the coins, people would bring the metal to the mint. However when prices of the metals rise beyond the face value of the coin, people will melt the coins (or export or hoard them) as the cheapest way of obtaining the metal, according to a book by Thomas J. Sargent and Francois R. Velde as reviewed by Leland B Yeager[32]

So this merely repeats the errors of the past.

But who is really responsible for the coin shortages? Well it has been no more than the government.

Writes Professor George Selgin[33]

Coin shortages are nothing new. A few months before running out of gold Eagles, the US Mint had to ration silver Eagles. Not long before that, pennies were in very short supply. Nor are other government mints any better. Back in 2007, for instance, Argentina had such a severe change shortage that its panhandlers nearly starved to death, while in southern China, 100-yuan coins commanded a whopping 25 percent premium.

Why are coin shortages so common? Governments typically blame unexpected changes in demand. But suppliers of all sorts of other goods manage to avoid running out, despite even more dramatic demand changes. So what's special about coins? An old chestnut says that if the government were put in charge of the desert, pretty soon there'd be a sand shortage. Recall the plight of consumers under socialism: socialist governments tried to make everything and eventually ran out of everything.

Now socialism is dead, but not when it comes to coining. So coin shortages keep breaking out, as they have ever since governments first monopolized coin making in ancient times.

It seems as the Philippine government has been passing their culpability to the private sector. And in doing so appear to be using such repressive edicts to harass and subjugate on the individual’s property rights. Also notice that inflationism have always been a part of the grand scheme of manifold interventions imposed on society—price and wage controls, capital and currency controls and social mobility or travel restrictions.

The seeming all out blitzkrieg by the government against the informal sector appear as signs that we may be headed in the direction of the Argentina. Add to this the 30% money supply growth. Such repression will become more evident when the bubble economy pops that will send fiscal deficits to the moon. 

Yet I hope the current political trend reverses.

If saving via coins has been constrained then foreign currency alternatives will likely be considered by the marketplace. This implies more pressure on the peso. As caveat foreign currencies are still paper money which are subject to relative inflationism.

Rotation or Risk ON or Bull Trap???

A final thought. Some say that the recent outperformance of Emerging Markets stocks (EEM—lower left window) relative to the US means a rotation and a return to the bullish backdrop.

I doubt such a premise. Using Philippine valuations (PER 30-60 for major blue chips) and signs of emerging price inflation will hardly be bullish for Philippine stocks.

In addition the weakness in the US markets has so far been led by biotechnology sector (not in charts), the Nasdaq (COMPQ—upper right) and the severely overvalued Russell 2000 (RUT—upper left) may be either a temporary reprieve or a periphery to core dynamic.

Yet even as longer end yields for US Treasuries have recently declined. Yields of 2 year USTs (UST2Y—lower right) have sharply risen.

Hardly a good news for a debt financed stock market boom.

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[1] Bangko Sentral ng Pilipinas, Monetary Board Keeps Policy Rates Steady, Adjusts Reserve Requirement March 27, 2014

[2] See Phisix: Have You Been Aware of This Week’s Peso Meltdown? March 24, 2014

[3] Bloomberg.com Philippine Peso Slump Amid Surplus Shows Smuggling Risk: Economy March 27, 2014

[4] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2014

[5] See Does The Government Deserve Credit Over Philippine Economic Growth? May 31, 2010

[6] International Monetary Fund, Philippines: Reform of the Fiscal Regimes for Mining and Petroleum August 2012

[7] see Philippine Informal Gold Mining Industry Booms august 24, 2012

[8] Metal.com Gold smuggling in India multiplied 14 times between FY '11 and FY '14 March 28, 2014

[9] See Philippine Politics: As Predicted, Cigarette Sin Taxes Backfires, Tax Revenues Fall as Smuggling Explodes November 2, 2013

[10] See Graphics: Cigarette ‘Sin’ Taxes Equals Smuggling US Edition Updated March 22, 2014

[11] Wikipedia.org Balance of payments

[12] Mark Perry Trade Deficit = Capital Inflow = BOP = 0 Carpe Diem October 25, 2010

[13] Wikipedia.org Balance of payments crisis, Balance of Payment

[14] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Rises in January February 28, 2014

[15] Nouriel Roubini and David Backus Chapter 7. Foreign Exchange Rates Lectures in Macroeconomics New York Sterns

[16] Ludwig von Mises 1 The Monetary Theory of Etatism CHAPTER 14 The Monetary Policy of Etatism Mises.org

[17] Ibid

[18] BSP loc cit March 27, 2014

[19] Bloomberg.com Philippine Two-Year Bonds Decline on Rate-Tightening Speculation March 24, 2014

[20] See Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013

[21] Bangko Sentral ng Pilipinas Annual Report 2013

[22] Misis wiki Fractional reserve banking

[23] Murray N. Rothbard 9. Central Banking Directing the Inflation Government Meddling With Money What Has Government Done to Our Money?

[24] Robert A. Lawson Economic Freedom The Concise Encyclopaedia of Economics Econolog

[25] Ludwig von Mises 1 The Classical Idea of Sound Money CHAPTER 21 The Principle of Sound Money, The Theory of Money and Credit

[26] Tempo.com.ph Bill vs coin hoarding passed March 25, 2014

[27] Wikipedia.org Gresham's law

[28] Global Post Where are Argentina's coins? May 11, 2009

[29] Wikipedia.org Coins Zimbabwean dollar

[30] Kurt Schuler A cell phone solution to coin shortages September 26, 2012

[31] See Philippines Moves to Ban Coin Collection May 16, 2012

[32] Leland B Yeager The Big Problem of Small Change Cato Journal

[33] George A Selgin Get Government Out of Coin Manufacture November 4 2008 Mises.org