The USD-PHP Hits Fresh 11 Year Highs! The Balance of Payment Has Hardly Been the Culprit; Sssh, It’s About…. (Secret!)

The USD-Philippine peso broke into a fresh 11-year high at 51.53 Thursday, before closing the week below the breakout point.

Fascinatingly, because it rose by a skimpy .12%, the peso was one of the best performing Asian currencies as the US strengthened against most Asian currencies this week.

Media and by their favorite mainstream experts have frequently stated that the infirmities manifested by the peso have not signified a weakness at all.  Instead, such is a reflection of underlying strength expressed through Balance of Payment conditions (deficits). 

Satisfying ‘domestic demand’ through trade deficits is a sign of strength, so it is held.

In short, trade and current account deficits are blessing in disguise!

The Balance of Payments (BoP) defined as the current account and the capital account, represents an accounting summary of an economy’s transactions with the rest of the world for a specified time period.

The current account, defined as the sum of the balance of trade (goods and services exports lessimports), net income from abroad and net current transfers, represents the difference between nation’s net savings and investment. A country is a net lender to the world when it posts a current account surplus. On the other hand, a country is a net borrower from the world when it registers a current account deficit.

The capital account, on the other hand, defined as foreign direct investment (FDI), portfolio and other investments, plus changes in the reserve account, signifies the net change in physical or financial asset ownership for a nation

Theoretically, the Balance of Payments should balance or show a net figure of zero. That would be because current account deficits will have been offset by capital surpluses and vice versa.

During the gold standard, flows in gold functioned as a natural financial and economic anchor to keep BoPs in “balance” or in equilibrium.

The international gold standard wrote Austrian economist Murray Rothbard*, provided an automatic market mechanism for checking the inflationary potential of government. It also provided an automatic mechanism for keeping the balance of payments of each country in equilibrium. [*Murray N Rothbard The Monetary Breakdown of the West Mises.org]

Today, under fiat monetary system, a crisis may emerge out of severe imbalances in the Balance of Payments conditions.

Notes the Wikipedia: (bold mine)

A BoP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports 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. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts denominated in foreign currencies, it generally further depresses the local economy

In short, the BoP can serve as a barometer for boom-bust cycles.

By the way, September BoP turned to a USD $24 million surplus.

 

The Philippine balance of payment and the USD peso have so far had little correlations.

The USD peso rose when the BOP had been in neutral or close to neutral (2000-2004) and even during periods when surpluses were substantial (2007-2008, 2013 and 2015). Conditions underlying these periods varied. 2000-2004 signified the epoch of rebalancing post-Asian Crisis, 2007-2008 represented external shocks and 2013-2015 could be the peak of the Philippine boom which had been rattled by the Taper tantrum.

Exports are the price paid for imports. Imports signify as the key benefits of trade. That's the theory.

 

But in the Philippines, fiscal policy plays a material role in determining the trade conditions

The nominal fiscal deficit coincided with the USD peso movements in 1998-2007.

When the fiscal deficit peaked in 2002, this coincided with climaxing of the trade deficit in the same year (shown both in nominal and % of GDP lower right).  With a time lag, the USD PHP climbed to its zenith in 2004.

When the trade balance and the fiscal deficit ebbed, the peso rallied.  During these days, the trade deficit was much a function of fiscal policy.

The opposite occurred in the post-Lehman period of 2009-2014. Fiscal deficits swooned, but trade deficits expanded.

Imports during this period would account for market forces rather than fiscal policy, thus signifying as the key benefits of trade.* One may argue justifiably that imports were about economic growth in this period. That would be because the private sector determined import activities.

* I’ll put aside here the influence of monetary policy.

But the mechanics changed in 2015 up to the present. Fiscal policy has once again played a crucial role in imports. The role of fiscal policy in shaping trade balance conditions has expanded in 2016 and the present. (lower right window) Thus, the crowding the effect from these political-economic actions will likely aggravate the US dollar shorts.

The greater the government spends, the more it influences the current account, the BoP and the Peso.

The purchasing power of money and the exchange rate is ultimately driven by the demand and supply. Thus, the demand and supply of the peso will operate relative to the demand and supply of the US dollar by Philippine residents.

Let us look at the supply side of the US dollar.

 

OFW remittances growth rates have pivoted lower since its peak in 2014. (middle window) The PSA’sapproved FDI continues to cascade in the 1H 2017. (upper right window) The BSP’s FDI flows have been up against the years prior to 2016 (July 2017), but debt constitutes a vast majority of these (upper left). Debt accounts for more US dollar shorts.

Growth rates in Gross International Reserves have become negative since February of 2017. Nominal foreign portfolio flows remain negative in the 9-months of 2017.

The establishment has now succumbed to the idea of lower growth rates for the BPO industry which they see at less than 10% this year and would taper off the coming years.

In short, US dollar supply will be scarce RELATIVE to the peso.

And to scare off peso bears, the BSP recently announced the renewal of foreign currency swaps with the Bank of Japan and with the central banks of ASEAN.

Even more, private sector as seen in many listed companies continues to load up on foreign debt. [More on Drowning in Debt: BDO, Ayala Corp, San Miguel and Subprime Emerging Markets September 10, 2017] This should increase future demand for US dollars.

Whether defined by Wikipedia or by the Austrian school, the BoP essentially will reflect on domestic inflationary policies.

 

The USD peso has had a tight correlation with the BSP’s undisclosed use of its nuclear option, especially from 2008 onwards. (upper window)

The USD peso began its steep descend in 2004 when the BSP scaled back from financing the National Government’s (NG) debt. 

When the Lehman crisis struck in 2008, the BSP used this emergency tool for a short period to stabilize the economy whereby the US peso responded with it by soaring to 50. When the BSP pulled back from NG debt subsidies in 2010 to 2013 the peso rallied strongly again.

The taper tantrum compelled the BSP to use this emergency tool again. The peso inflected and began to lose ground. When the BSP pulled back, money supply exploded as the private sector credit roared. The peso lost further ground. In 2015, the BSP decisively used the nuclear option as a regular tool. Thus, the misery of the peso has been sustained.

The mainstream may adamantly IGNORE this, but this has and IS the strongest of all forces to influence the peso.

Money supply has merely been responding to the banking system and or to the BSP’s efforts to shore up the NG.

With the NG rarin’ to spend, just how will they be able to finance such splurges once nominal prices fall? Two days ago, the Department of Budget and Management appealed to congress to raise wages of military personnel by 100%! That’s aside from more military hardware, build, build and build, free college, bigger bureaucracy and more free stuffs for special interest groups.

Moreover, the BSP has oriented the private sector to become hooked to debt.  And how will all these ever mushrooming malls, real estate projects, and hotels survive if money supply growth, pillared on debt, dawdles? And how will they generate revenues for this spendthrift government?

As I have been saying here, the BSP has been playing with fire. And play with fire we get burned. It would be less of the government who will get singed. It will rather be the average citizen, whose purchasing power will wretchedly shrivel.

Anytime a slowdown or stagflation comes to the fore, expect the peso’s downfall to accelerate.

Buy on dips the US dollar-php!

George Selgin: Ten Things Every Economist Should Know about the Gold Standard

At the Ideas for an Alternative Monetary Future (Alt-M) website, George Selgin director of the Cato Institute's Center for Monetary and Financial Alternatives, Professor Emeritus of economics at the Terry College of Business at the University of Georgia, and an associate editor of Econ Journal Watch addresses 10 controversial issues (myths & facts) surrounding the classic Gold Standard

1. The Gold Standard wasn't an instance of government price fixing. Not traditionally, anyway.
2. A gold standard isn't particularly expensive. In fact, fiat money tends to cost more.

3. Gold supply "shocks" weren't particularly shocking.

4. The deflation that the gold standard permitted  wasn't such a bad thing.

5.  It wasn't to blame for 19th-century American financial crises.

6.  On the whole, the classical gold standard worked remarkably well (while it lasted).

7.  It didn't have to be "managed" by central bankers.

8.  In fact, central banking tends to throw a wrench in the works.

9.  "The "Gold Standard" wasn't to blame for the Great Depression.

10.  It didn't manage money according to any economists' theoretical ideal.  But neither has any fiat-money-issuing central bank.

Below are four of my favorites: (bold mine)

1.  The Gold Standard wasn't an instance of government price fixing.  Not traditionally, anyway.

As Larry  White has made the essential point as well as I ever could, I hope I may be excused for quoting him at length:

Barry Eichengreen writes that countries using gold as money 'fix its price in domestic-currency terms (in the U.S. case, in dollars).'   He finds this perplexing:

But the idea that government should legislate the price of a particular commodity, be it gold, milk or gasoline, sits uneasily with conservative Republicanism’s commitment to letting market forces work, much less with Tea Party–esque libertarianism.  Surely a believer in the free market would argue that if there is an increase in the demand for gold, whatever the reason, then the price should be allowed to rise, giving the gold-mining industry an incentive to produce more, eventually bringing that price back down. Thus, the notion that the U.S. government should peg the price, as in gold standards past, is curious at the least.

To describe a gold standard as "fixing" gold’s "price" in terms of a distinct good, domestic currency, is to get off on the wrong foot.  A gold standard means that a standard mass of gold (so many grams or ounces of pure or standard-alloy gold) defines the domestic currency unit.  The currency unit (“dollar”) is nothing other than a unit of gold, not a separate good with a potentially fluctuating market price against gold.  That one dollar, defined as so many grams of gold, continues be worth the specified amount of gold—or in other words that one unit of gold continues to be worth one unit of gold—does not involve the pegging of any relative price. Domestic currency notes (and checking account balances) are denominated in and redeemable for gold, not priced in gold.  They don’t have a price in gold any more than checking account balances in our current system, denominated in fiat dollars, have a price in fiat dollars.  Presumably Eichengreen does not find it curious or objectionable that his bank maintains a fixed dollar-for-dollar redemption rate, cash for checking balances, at his ATM.

Remarkably, as White goes on to show, the rest of Eichengreen's statement proves that, besides not having understood the meaning of gold's "fixed" dollar price, Eichengreen has an uncertain grasp of the rudimentary economics of gold production:

As to what a believer in the free market would argue, surely Eichengreen understands that if there is an increase in the demand for gold under a gold standard, whatever the reason, then the relative price of gold (the purchasing power per unit of gold over other goods and services) will in fact rise, that this rise will in fact give the gold-mining industry an incentive to produce more, and that the increase in gold output will in fact eventually bring the relative price back down.

I've said more than once that, the more vehement an economist's criticisms of the gold standard, the more likely he or she knows little about it.  Of course Eichengreen knows far more about the gold standard than most economists, and is far from being its harshest critic, so he'd undoubtedly be an outlier in  the simple regression, y =   α + β(x) (where y is vehemence of criticism of the gold standard and x is ignorance of the subject).  Nevertheless, his statement shows that even the understanding of one of the gold standard's most well-known critics leaves much to be desired.

Although, at bottom, the gold standard isn't a matter of government "fixing" gold's price in terms of paper money, it is true that governments' creation of monopoly banks of issue, and the consequent tendency for such monopolies to be treated as government- or quasi-government authorities, ultimately led to their being granted sovereign immunity from the legal consequences to which ordinary, private intermediaries are usually subject when they dishonor their promises. Because a modern central bank can renege on its promises with impunity, a gold standard administered by such a bank more closely resembles a price-fixing scheme than one administered by a commercial bank.  Still, economists should be careful to distinguish the special features of a traditional gold standard from those of  central-bank administered fixed exchange rate schemes. 

5.  It wasn't to blame for 19th-century American financial crises.

Speaking of 1873, after claiming that a gold standard is undesirable because it makes deflation (and therefore, according to his reasoning, depression) more likely, Krugman observes:

The gold bugs will no doubt reply that under a gold standard big bubbles couldn’t happen, and therefore there wouldn’t be major financial crises. And it’s true: under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933.  Oh, wait.

Let me see if I understand this.  If financial  crises happen under base-money regime X, then that regime must be the cause of the crises, and is therefore best avoided.  So if crises happen under a fiat money regime, I guess we'd better stay away from fiat money.  Oh, wait.

You get the point: while the nature of an economy's monetary standard may have some bearing on the frequency of its financial crises, it hardly follows that that frequency depends mainly on its monetary standard rather than on other factors, like the structure, industrial and regulatory, of the financial system.

That U.S. financial crises during the gold standard era had more to do with U.S. financial regulations than with the workings of the gold standard itself is recognized by all competent financial historians.    The lack of branch banking made U.S. banks  uniquely vulnerable to shocks, while Civil-War rules linked the supply of banknotes to the extent of the Federal government's indebtedness., instead  of allowing that supply to adjust with seasonal and cyclical needs.   But there's no need to delve into the precise ways in which  such misguided legal restrictions to the umerous crises to which  Krugman refers. It should suffice to point out that Canada, which employed the very same gold dollar, depended heavily on exports to the U.S., and (owing to its much smaller size) was far less diversified, endured no banking crises at all, and very few bank failures, between 1870 and 1939.

6.  0n the whole, the classical gold standard worked remarkably well (while it lasted).

Since Keynes's reference to gold as a "barbarous relic" is so often quoted by the gold standard's critics,  it seems only fair to repeat what Keynes had to say, a few years before, not about gold per se, itself, but about the gold-standard era:

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot.  But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.  The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages… He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank or such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference.  But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

It would, of course, be foolish to suggest that the gold standard was entirely or even largely responsible for this Arcadia, such as it was.  But it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was "normal, certain, and permanent." 

The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.  According to Finn Kydland and Mark Wynne:

The contrast between the price stability that prevailed in most countries under the gold standard and the instability under fiat standards is striking. This reflects the fact that under commodity standards (such as the gold standard), increases in the price level (which were frequently associated with wars) tended to be reversed, resulting in a price level that was stable over long periods. No such tendency is apparent under the fiat standards that most countries have followed since the breakdown of the gold standard between World War I and World War II.

The high degree of price level predictability, together with the system of fixed exchange rates that was incidental to the gold standard's widespread adoption, substantially reduced the riskiness of both production and international trade, while the commitment to maintain the standard resulted, as I noted, in considerably lower international borrowing costs. 

Those pundits who find it easy to say "good riddance" to the gold standard, in either its classical or its decadent variants, need to ask themselves what all the fuss over monetary "reconstruction" was about, following each of the world wars, if not achieving a simulacrum at least of the stability that the classical  gold standard achieved.  True, those efforts all failed.  But that hardly means that the ends sought weren't very worthwhile ones, or that those who sought them were "lulled by the myth of a golden age."  Though they may have entertained wrong beliefs concerning how the old system worked, they weren't wrong in believing that it did work, somehow.

Finally: 9.  "The "Gold Standard" wasn't to blame for the Great Depression.

I know I'm about to skate onto thin ice, so  let me be more precise.  To say that "The gold standard caused the Great Depression " (or words to that effect, like "the gold standard was itself the principal threat to financial stability and economic prosperity between the wars”), is at best extremely misleading.  The more accurate claim is that the Great Depression was triggered by the collapse of the jury-rigged version of the gold standard cobbled together after World War I, which was really a hodge-podge of genuine, gold-exchange, and gold-bullion versions of the gold standard, the last two of which were supposed to "economize" on gold.    Call it "gold standard light."

Admittedly there is one sense in which the real gold standard can be said to have contributed to the disastrous shenanigans of the 1920s, and hence to the depression that followed.  It contributed by failing to survive the outbreak of World War I.  The prewar gold standard thus played the part of Humpty Dumpty to the King's and Queen's men who were to piece the still-more-fragile postwar arrangement together.  Yet even this is being a bit unfair to gold, for the fragility of the  gold standard on the eve of World War I was itself largely due to the fact that, in most of the belligerent nations, it had come to be administered by central banks that were all-too easily dragooned by their sponsoring governments into serving as instruments of wartime inflationary finance.

Kydland and Wynne offer the case of the Bank of Sweden as illustrating the practical impossibility of preserving a gold standard in the face of a major shock:

During the period in which Sweden adhered to the gold standard (1873–1914), the Swedish constitution guaranteed the convertibility into gold of banknotes issued by the Bank of Sweden.  Furthermore, laws pertaining to the gold standard could only be changed by two identical decisions of the Swedish Parliament, with an election in between. Nevertheless, when World War I broke out, the Bank of Sweden unilaterally decided to make its notes inconvertible. The constitutionality of this step was never challenged, thus ending the gold standard era in Sweden.

The episode seems rather less surprising, however, when one considers that "the Bank of Sweden," which secured a monopoly of Swedish paper currency in 1901, is more accurately known as the Sveriges Riksbank, or "Bank of the Swedish Parliament."

If the world crisis of the 1930s was triggered by the failure, not of the classical gold standard, but of a hybrid arrangement, can it not be said that the U.S. , which was among the few nations that retained a full-fledged gold standard, was fated by that decision to suffer a particularly severe downturn?  According to Brad DeLong,

Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.

It's true that Hoover tried to balance the Federal budget, and that his attempt to do so had all sorts of unfortunate consequences.   But the gold standard, far from forcing his hand, had little to do with it.  Hoover simply subscribed to the prevailing orthodoxy favoring a balanced budget.  So, for that matter, did FDR, until events forced him too change his tune: during the 1932 presidential campaign the New-Dealer-to-be assailed his opponent both for running a deficit and for his government's excessive spending.

As for the gold standard's having prevented the Fed from expanding the money supply (or, more precisely, from expanding the monetary base to keep the broader money supply from shrinking), nothing could be further from the truth.  Dick Timberlake sets  the record straight:

By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act.  Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves.

Moreover,

Whether Fed Banks had excess gold reserves or not, all of the Fed Banks’ gold holdings were expendable in a crisis.  The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period.

Nor, according to a statistical study by Chang-Tai Hsieh and Christina Romer, did the Fed have reason to fear that by allowing its reserves to decline it would have raised fears of  a devaluation.    On the contrary: by taking steps to avoid a monetary contraction, the Fed would have helped to allay fears of a devaluation, while, in Timberlake's words,  initiating a "spending dynamic" that would have  helped to restore "all the monetary vitals both in the United States and the rest of the world."

Read the rest here