In a progressing economy the production processes are longer and more productive due to an increase in gross investment and capital accumulation, supported by growing savings as time preference and interest rates fall. In a regressing economy, the opposite is true—gross savings and investment decline and consumption increases. Time preference increases together with the interest rate, widening the spread between cumulative prices in the stages of production (Rothbard [1962] 2009, 531). Wicksell ([1898] 1962, xi) argues in the same way that the real rate of interest will fall when the quantity of real capital increases—Dr. Mihai Macovei
In this issue:
Navigating the Risks of the Record Philippines’ Savings-Investment Gap, February Public Debt Hits All-Time High and March CPI Reinforces the Deficit-CPI Cycle Tango
I. The Savings-Investment Gap Represents the Philippine Economic Development Paradigm
II. The SIG’s Three Fatal Flaws
III. Speculative Activities or Malinvestments Drain Savings; Promotes Inequality
IV. Deficit Spending Depletes Savings
V. The SIG: A Manifestation of a Credit Bubble and its Inherent Consumption of Savings
VI. Intrinsic Inflationary Pressures of the SIG: Escalating Risks Ahead
VII. February’s Record High Public Debt and Historic Government Liquidity
VIII. Government’s Aggressive Borrowing: Is it Because of a Coming Stimulus, a Surge in Defense or Pre-Election Spending?
IX. March 3.7% CPI Reveals that the Fiscal Deficit-CPI Cycle Tango Remains Intact
Navigating the Risks of the Record Philippines’ Record Savings-Investment Gap, February Public Debt Hits All-Time High and March CPI Reinforces the Deficit-CPI Cycle Tango
The widening and record Savings-Investment Gap exhibit the entrenched and deepening dependence on systemic leveraging. This, in turn, increases the fragility of the economy and financial system.
I. The Savings-Investment Gap Represents the Philippine Economic Development Paradigm
Figure 1
Businessworld, April 3, 2024: The savings-investment gap (S-I) gap, the difference between gross domestic savings and gross capital formation, reflects a country’s ability to finance its overall investment needs. An S-I deficit happens when a country’s investment expenditures exceed its savings, leading a country to borrow to fund the gap. In 2023, the country’s savings rate — gross domestic savings as a share of gross domestic product (GDP) — reached 9.2% (P2.23 trillion) while the investment rate stood at 23.4% (P5.7 trillion) of GDP, resulting in a P3.47-trillion gap. (bold added)
First, the Definition of Terms: (bold mine)
Gross capital formation (GCF) is measured by the total value of the gross fixed capital formation, changes in inventories and acquisitions less disposals of valuables for a unit or sector. (PSA, GRDP)
Gross fixed capital formation (GFCF) is defined as the acquisition of produced assets (including purchases of second-hand assets), including the production of such assets by producers for their own use, minus disposals.
The gross savings of the sector is the difference between the total income and the sum of uses of income. (PSA, 2022)
General government: The following are the components of income of the general government: gross operating surplus (which only includes the fixed capital formation), property income, taxes on production and on imports, current taxes on income and wealth, etc., compulsory fees and fines, social contributions, and other current transfers. (PSA, 2022)
Why is this chart important?
The savings-investment gap (SIG) represents the developmental paradigm of the Philippine economy.
Or, this chart, based on the Keynesian concept that "spending drives the economy," is the essence of the domestic GDP.
Savings, in this context, signify a hindrance to spending and, therefore, to "statistical growth."
As a side note, government fixed assets are part of "investments."
It tells us something we've been saying for a long time: savings (even by the government's definition) have been trending lower—and adrift at all-time lows—even as physical stocks (investments) in 2023 remained below the 2018 peak.
That noted, the SIG was at its highest level in 2023!
But as the article noted, this deficit leads a "country to borrow to fund the gap."
As we have previously observed,
With the government and major corporations as net borrowers and the low levels of household savings, the domestic political economy increasingly depends on foreign savings to fill its FX requirements gap. (Prudent Investor, 2024)
II. The SIG’s Three Fatal Flaws
Yet, this economic model has three fundamental fatal flaws:
One, it disregards productivity from entrepreneurial activities.
Two, it ignores the impact of endless borrowing on household, corporate, and even public balance sheets, and its effect on the economy (prices, production, and allocation).
Three, because it adheres to the top-down framework for its growth model, it discounts 'opportunity costs.'
III. Speculative Activities or Malinvestments Drain Savings; Promotes Inequality
Productive investments should increase, not decrease, savings.
As Dr. Macovei explained:
If time preference goes down in a society and the saving propensity grows, the increase in real savings would be matched by an increase in real investments, i.e., the saving-investment pattern would shift simultaneously. (Macovei, 2021)
Why would productive investments cause a drain in savings?
Further, the notion of boosting returns by requiring the ramping up of leverage translates to increasingly riskier speculative activities—amplifying probabilities of losses and unproductive undertakings. In a word, malinvestments.
Increasing leverage also translates to more spending than income.
With the penetration level of bank credit with a paltry 17.4% of the adult population (World Bank Findex 2021), according to the BSP's Q1 2023 Financial Inclusion Report, this elite group comprises the chief beneficiaries of the BSP’s "trickle-down" policies of borrowing to spend.
Thus, the BSP's easy money policies implicitly redistribute wealth from savers to borrowers, or from the underprivileged and the middle class to these elites.
Such widening inequality, therefore, constitutes an 'opportunity costs' from a broader or 'inclusive' (to borrow the mainstream’s lingo) economic growth.
IV. Deficit Spending Depletes Savings
Magnifying government activities to substitute the slack from the private sector also redistributes wealth from taxpayers and currency holders to tax consumers.
The so-called "investments" by the government are, in reality, consumption activities funded by present taxes, future taxes (debt), and inflation. Because these represent consumption, these activities drain on the savings.
Also, public activities magnify the inequitable distribution of cash flow, income, and wealth to the government and the connected few in the private sector partaking in these political projects.
V. The SIG: A Manifestation of a Credit Bubble and its Inherent Consumption of Savings
The thing is, this unbounded credit creation to fund political projects or speculative undertakings represents a credit bubble.
Figure 2
Thus, the surging SIG signifies a disguised credit bubble, effectively taking the shape of the GDP.
An inflating credit bubble diminishes savings, a fact that becomes apparent when it eventually implodes.
System leverage (bank lending + public debt) reached Php 26.942 trillion in January 2024, accounting for 111% of the NGDP. The data excludes all other forms of leverage, such as capital markets, derivatives, shadow banking, informal financing, and FDI debt. (Figure 2, upper chart)
VI. Intrinsic Inflationary Pressures of the SIG: Escalating Risks Ahead
The insufficiency of production stemming from dislocations, as a consequence of credit-fueled speculative momentum activities and the relentless upward trend of public spending, results in what is known as the 'twin deficits.'
These deficits often necessitate tapping overseas funding or increasing inflation to reduce the 'real' debt burden.
Philippine external debt reached USD 125.4 billion—a record high—in the last quarter of 2023. (Figure 2, lower graph)
By extension, because economic and financial imbalances arise from resource misallocations due to speculative activities and public expenditures relative to credit-funded demand, this results in inflation.
Accordingly, the SIG is inherently inflationary, which results in the debasement of the purchasing power of the peso—an indirect consumption of the public's savings.
Overall, the SIG economic model reduces the average citizen's standard of living through boom-bust cycles and inflation, which can be seen as a form of tacit political redistribution.
Moreover, the SIG model depends not only on unfettered access to domestic and foreign savings but also on two other principal considerations: easy monetary conditions and liberal capital flows.
However, deepening deglobalization and the prospect of 'higher for longer' international rates pose a pivotal risk to sustaining this model.
As the late economist Herb Stein wrote (Stein’s Law), "If something cannot go on forever, it will stop."
VII. February’s Record High Public Debt and Historic Government Liquidity
Transitioning from the SIG framework to present developments, we'll examine two recent entwined aspects: the fiscal deficit of the last two months and March inflation.
Philstar.com, April 2, 2024: The government reverted back to a budget deficit in February after a quick surplus at the start of the year, but a narrower gap can still be expected as the tax season draws near. Data from the Bureau of the Treasury showed that the government swung back to a budget deficit of P164.7 billion in February from a brief surplus of P88 billion in January…For the two-month period, the budget deficit also picked up by 27 percent to P76.7 billion from P60.6 billion as state spending outpaced the expansion of revenue collections.
The sharp reversal in February’s fiscal balance wasn't surprising, given the DBCC's 5.1% deficit-to-GDP target for 2024.
Figure 3
However, instead of a boom in public spending, the deficit surge in February stemmed from a sharp decline in revenue growth (+5.73%) following January's surge (+21.2%)—caused by regulatory reporting adjustments. (Figure 3, topmost image)
Even so, the two-month deficit of Php 76.7 billion accounted for the third largest, outpacing last year's Php 60.6 billion. Treasury borrowings of Php 536 billion also signified the third-largest. Meanwhile, the Treasury's cash holdings sprinted to an all-time high of Php 1.26 trillion, marking a threefold increase! (Figure 3, middle chart)
Much of the debt came from the Treasury's issuance of Php 584.5 billion in retail bonds in February.
Consequently, the Philippine debt stock soared to a fresh all-time high of Php 15.178 trillion, with February's Php 388 billion expansion accounting for the largest monthly increase since September 2022! (Figure 3, lowest visual)
Figure 4
The debt stock has surged significantly beyond the level of public spending. (Figure 4, topmost graph)
Nonetheless, the government is swimming in liquidity! And yet, are we to believe that the BSP is "tightening?"
VIII. Government’s Aggressive Borrowing: Is it Because of a Coming Stimulus, a Surge in Defense or Pre-Election Spending?
Why has the government been borrowing aggressively?
Could it be because debt servicing in February and the first two months of 2024 reached a record high? (Figure 4, middle and lowest charts)
Are authorities preparing for a jump in amortizations, which are excluded from expenditure allocations?
Is the government expecting a sharp downturn, prompting them to raise liquidity as a contingency? The government revised downward its GDP projection for 2024 last week.
Once again, while expenditures are programmed, revenues stem from economic conditions and the efficiency of tax administration. Thus, economic weakness has the potential to derail the government's deficit targets.
The NEDA chief was recently quoted saying, "It’s not in our best interest to drastically reduce our (budget) deficit because that will affect our growth."
Using reductio ad absurdum to address this premise, why should the government stop at a 5.1% budget-to-GDP ratio in 2024? If deficits represent the wellspring of economic prosperity, why not 50%? Pushing it to the limits, why not 100% or the embrace of full socialism?
Would further increases in the budget deficit not exacerbate the Savings-Investment Gap (SIG)?
What areas might be targeted for such increases?
Defense spending, perhaps, especially in light of the escalating territorial disputes with China.
Alternatively, could it be preparations for the 2025 national elections or pre-election spending?
Figure 5
The surge in February's Local Government Unit (LGU) allocations echoes the upsurge seen in Q1 2020, with the LGU spending binge peaking in the post-election period of August 2022. (Figure 5, topmost pane)
Or could it be a combination of all three: stimulus, defense, and pre-election spending?
It's intriguing, particularly for administration officials to assert that there will be no tax increases during the incumbent leadership's term. This forecast relies on either a sustained upturn in the economy or the possibility that authorities will opt for the increased use of the inflation tax rather than implementing direct taxes.
As an adage goes, "Never believe anything until it is officially denied."
Our bet is that the deeper embrace of the SIG translates to the next wave of the inflation cycle and higher taxes, which are coming very soon.
IX. March 3.7% CPI Reveals that the Fiscal Deficit-CPI Cycle Tango Remains Intact
On that note, March CPI of 3.7% reportedly beat the consensus estimates of 3.8%. This marked the second consecutive month of increases for the CPI, which was primarily attributed to rising rice prices.
Reuters, April 5, 2024: Philippine annual inflation accelerated for the second straight month in March as the rice component jumped at the fastest pace in 15 years, giving the central bank reason to keep policy settings tight. The consumer price index rose 3.7% in March from a year earlier, the statistics agency said on Friday, picking up from the previous month's rate of 3.4%. Economists in a Reuters poll had forecast annual inflation in March at 3.8%, within the central bank's 3.4% to 4.2% forecast for the month
Sure, after the BSP chief upped his forecast to 3.9% in the third week of March, the flock of sheep followed their shepherd with higher projections. And so, the CPI beat.
While the consensus views inflation as primarily driven by supply-side factors and considers it "transitory, " our position is that deficits, which create economic imbalances, contribute to higher prices.
This is compounded by misallocations resulting from the BSP's liquidity-driven business cycle.
It comes as no surprise that the surge in fiscal spending, resulting in historic deficits, has coincided with the uptrend in the CPI. (Figure 5, middle and lowest charts)
Furthermore, with the Philippine savings rate at its lowest level, insufficient to fund the rapid growth of public debt (SIG), banks have become the primary source of funding.
Figure 6
The banking system's Net claims on the central government (NGoC) have been relentlessly increasing skyward. It grew by 15.9% YoY to the second-highest level of Php 5.015 trillion in January, which accounted for about 34.2% of the Php 14.8 trillion public debt over the same period. (Figure 6, topmost image)
The injected liquidity is expected to continue percolating into the system, resulting in uneven increases in relative prices.
Furthermore, the government will continue to blame "greed" on the marketplace until the fundamental laws of economics expose the underlying realities
Lastly, it is remarkable how the establishment portrays inflation as merely a statistic that represents the government's control valve. Does the average person care about the CPI rate? They care about the prices of goods and services they interact with and the purchasing power of their money. Despite falling CPI, the loss of purchasing power remains a top concern of the public, according to this survey.
The government can declare whatever numbers they wish to seduce gullible savers into funding their boondoggle, but eventually, inflation would erode society’s moral fiber and social cohesion.
In any case, the USD Philippine Peso exchange rate ($USDPHP) should be one of its best barometers and hedge against inflation. (Figure 6, middle and lowest charts)
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References:
Dr. Mihai Macovei, The Case Against the New "Secular Stagnation Hypothesis," Quarterly Journal of Austrian Economics, September 4, 2021, Mises.org
Philippine Statistics Authority, Technical notes, The Country’s Total Gross Saving in 2022 Expands to PhP 4.90 Trillion June 29,2023, PSA.gov.ph
Philippine Statistics Authority, Gross Regional Domestic Expenditure, PSA.gov.ph
Philippine Statistics Authority. (2022). Technical Notes on the Consolidated Accounts, and Income and Outlay Accounts. PSA.gov.ph
Prudent Investor, January 2024’s Seasonal Fiscal Surplus in the Shadow of DBCC’s 5.1% Deficit-to-GDP Target, What Higher for Longer International Rates Means Substack, March 18,2024
