Showing posts with label interest rate. Show all posts
Showing posts with label interest rate. Show all posts

Monday, January 13, 2014

Phisix: Will a Black Swan Event Occur in 2014?

2013 turned out to be a very interestingly volatile and surprising year. It was a year of marked by illusions and false hope.

Mainstream’s Aldous Huxley Syndrome

The Philippine Phisix appears to be playing out what I had expected: the business cycle, or the boom-bust cycle. Business cycles are highly sensitive to interest rate movements.

At the start of 2013 I wrote[1],
the direction of the Phisix and the Peso will ultimately be determined by the direction of domestic interest rates which will likewise reflect on global trends.

Global central banks have been tweaking the interest rate channel in order to subsidize the unsustainable record levels of government debts, recapitalize and bridge-finance the embattled and highly fragile banking industry, and subordinately, to rekindle a credit fueled boom.

Yet interest rates will ultimately be determined by market forces influenced from one or a combination of the following factors as I wrote one year back: the balance of demand and supply of credit, inflation expectations, perceptions of credit quality and of the scarcity or availability of capital.
The Philippine Phisix skyrocketed to new record highs during the first semester of the year only to see those gains vaporized by the year end.


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During the first half of the year, I documented on how Philippine stocks has segued into the mania phase of the bubble cycle backed by parabolic rise by the Phisix index (for the first four months the local benchmark rose by over 5% each month!) and the feting or glorification of the inflationary boom via soaring prices of stocks and properties by the mainstream on a supposed miraculous “transformation[2]” of the Philippine economy backed by new paradigm hallelujahs such as the “Rising Star of Asia”[3], “We have the kind of economy that every country dreams of”[4], underpinned by credit rating upgrades, which behind the scenes were being inflated by a credit boom. This romanticization of inflationary boom is what George Soros calls in his ‘reflexivity theory’ as the stage of the flaw in perceptions and the climax[5].

While I discussed the possibility of a Phisix 10,000 as part of the inflationary boom process, all this depended on low interest rates.

But when US Federal Reserve chairman suddenly floated the idea of the ‘tapering’ or reduction of Large Scale Asset Purchases (LSAP) global equity markets shuddered as yields of US treasuries soared. Yields of US treasuries have already been creeping higher since July 2012 although the ‘taper talk’ accelerated such trend.

Since June 2013, ASEAN equity markets have struggled and diverged from developing markets as the latter went into a melt-up mode.

Just a week before the June meltdown I warned of the escalating risk environment due to the rising yields of Japanese Government Bonds (JGB) and US treasuries[6].
However, if the bond vigilantes continue to reassert their presence and spread, then this should put increasing pressure on risk assets around the world.

Essentially, the risk environment looks to be worsening. If interest rates continue with their uptrend then global bubbles may soon reach their maximum point of elasticity.

We are navigating in treacherous waters.

In early April precious metals and commodities felt the heat. Last week that role has been assumed by Japan’s financial markets. Which asset class or whose markets will be next?
Anyone from the mainstream has seen this?

Since the June meltdown, instead of examining their premises, the consensus has spent literally all their efforts relentlessly denying in media the existence of bear market which they see as an “anomaly” and from “irrational behavior”. 

They continue to ‘shout’ statistics, as if activities of the past signify a guaranteed outcome of the future, and as if the statistical data they use are incontrovertible. They ignore what prices have been signaling.

My favorite iconoclast and polemicist Nassim Nicolas Taleb calls this mainstream devotion on statistical numbers as the ‘Soviet-Harvard delusion’ or the unscientific overestimation of the reach scientific knowledge.

He writes[7], (bold mine)
Our idea is to avoid interference with things we don’t understand. Well, some people are prone to the opposite. The fragilista belongs to that category of persons who are usually in suit and tie, often on Fridays; he faces your jokes with icy solemnity, and tends to develop back problems early in life from sitting at a desk, riding airplanes, and studying newspapers. He is often involved in a strange ritual, something commonly called “a meeting.” Now, in addition to these traits, he defaults to thinking that what he doesn’t see is not there, or what he does not understand does not exist. At the core, he tends to mistake the unknown for the nonexistent.
English writer Aldous Huxley once admonished “Facts do not cease to exist because they are ignored.” Thus I would call mainstream’s rabid denial of reality the Aldous Huxley syndrome

Mainstream pundits like to dismiss the massive increase in debt which had supported the current boom. They use superficial comparisons (as debt to GDP) to justify current debt levels. They don’t seem to understand that debt tolerance function like individual thumbprints and thus are unique. They treat statistical data with unquestioning reverence.

I’ll point out one government statistical data which I recently discovered as fundamentally impaired. What I question here is not the premise, but the representativeness of the data.

The Philippine Bangko Sentral ng Pilipinas (BSP) recently came out with 2012 Flow of Funds report noting that the households had been key provider of savings for the fifth year[8].

Going through the BSP’s “technical notes”[9] or the methodology for construction of the flow of funds for the households, the BSP uses deposits based on the banking sector, loans provided by life insurances, GSIS, SSS, Philippine Crop Insurance and Home Development Mutual Fund, Small Business Guarantee and Finance Corporation and National Home Mortgage and Finance Corporation. They also include “Net equity of households in life insurances reserves and in pension funds”, “Currency holdings of the household” and estimated accounts payable by households, as well as “entrepreneurial activities of households” and “other unaccounted transactions in the domestic economy”[10]

But the BSP in her annual report covering the same year says that only 21.5 households are ‘banked’[11]. Penetration level of life insurance, according to the Philam Life, accounts for only 1.1% of the population[12]. SSS membership is about 30 million[13] or only about a third of the population. GSIS has only 1.1 million members[14]. These select institutions comprise the meat of formal system’s savings institutions from which most of the BSP’s data have been based.

Yet even if we look at the capital markets, the numbers resonate on the small inclusion of participants—the Phisix has 525,085 accounts as of 2012[15] or less than 1% of the population even if we include bank based UITFs or mutual funds and a very minute bond markets composed mainly of publicly listed entities.

So no matter how you dissect these figures, the reality is that much of the savings by local households have been kept in jars, cans or bottles or the proverbial “stashed under one's mattress”.

In the same way, credit has mostly been provided via the shadow banking sector particularly through “loan sharks”, “paluwagan” or pooled money, “hulugan” instalment credit or personal credit[16].

In short, the BSP cherry picks on their data to support a tenuous claim.

In fairness, the BSP has been candid enough to say, at their footnotes, that the database for the non-financial private sector covers only “the Top 8000 corporations” and that for the “lack of necessary details” their “framework may have resulted to misclassification of some transactions”.

But who reads footnotes or even technical notes?

The Secret of the Philippine Credit Bubble

This selective data mining has very significant implications on economic interpretation and analysis.

This only means that many parts of the informal economy (labor, banking and financial system, remittances[17]) has been almost as large as or are even bigger than their formal counterparts.

We can therefore extrapolate that the statistical economy has not been accurately representative of the real economy.

Yet the mainstream has been obsessed with statistical data which covers only the formal economy.

And in theory, the still largely untapped domestic banking system and capital markets by most of the citizenry hardly represents a sign of real economic growth for one principal reason: The major role of banks and capital markets is to intermediate savings and channel them into investments. With lack of savings, there will be a paucity of investments and subsequently real economic growth.

In short, the dearth of participation by a large segment of the Philippine society on formal financial institutions represents a structural deficiency for the domestic political economy.

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Any wonder why the mainstream pundits with their abstruse econometric models can’t capture or can’t explain why Philippine investments[18] have remained sluggish despite a supposed ‘transformational’ boom today?

This also puts to the limelight questionable efforts or policies by the government to generate growth via “domestic demand”.

Yet the mainstream hardly explains where “demand” emanates from? Demand may come from the following factors: productivity growth, foreign money, savings, borrowing and the BSP’s printing money.

With hardly significant savings to tap, and with foreign flows hobbled by rigid capital controls, the corollary—shortage of investments can hardly extrapolate to a meaningful productivity growth or real economic growth.

So in recognition of such shortcoming, the BSP has piggybacked on the global central bank trend in using low interest rates (then the Greenspan Put) to generate ‘aggregate demand’.

As a side note; to my experience, a foreign individual bank account holder can barely make a direct transfer from his/her peso savings account to a US dollar account and vice versa without manually converting peso to foreign exchange and vice versa due to BSP regulations.

The BSP anticipated this credit boom and consequently concocted a policy called the Special Deposit Accounts (SDA) in 2006, which has been aimed at siphoning liquidity[19]. Eventually the SDA backfired via financial losses on the BSP books even as the credit boom intensified.

The BSP imposed a partial unwinding of the SDA which today has only exacerbated the credit boom.

Given the insufficient level of participation by residents in the banking sector and the capital markets, thus the major beneficiaries and risks from the zero bound rate impelled domestic credit boom meant to generate statistical growth have been concentrated to a few bank account owners, whom has accessed the credit markets. This in particular is weighted on the supply side, e.g. San Miguel

The credit boom thus spurred a domestic stock market and property bubble.

This has been the secret recipe of the so –called transformational booming economy.

Yet, the large unbanked sector now suffers from the consequences of a credit boom—rising price inflation.

Well didn’t I predict in 2010 for this property bubble to occur?

Here is what wrote in September 2010[20]
The current “boom” phase will not be limited to the stock market but will likely spread across domestic assets.

This means that over the coming years, the domestic property sector will likewise experience euphoria.

For all of the reasons mentioned above, external and internal liquidity, policy divergences between domestic and global economies, policy traction amplified by savings, suppressed real interest rate, the dearth of systemic leverage, the unimpaired banking system and underdeveloped markets—could underpin such dynamics.
My point is that these bubbles have been a product of the policy induced business cycle.

Also these can hardly represent real economic growth without structural improvements in the financial system via a financial deepening or increased participation by the population in the banking sector and in the capital markets. 

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The chart from a recent World Bank report[21] represents a wonderful depiction of the distinctiveness of the distribution credit risks of ASEAN and China.

From the Philippine perspective, households indeed have very small debt exposure basically because of low penetration levels in the Philippine financial system. Whereas most of the insidious and covert debt build up has been in the financial, nonfinancial corporations and the government.

Ironically, Indonesia whom has very low debt levels has been one of the focal point of today’s financial market stresses which I discuss in details below.

This only shows that there are many complex variables that can serve as trigger/s to a potential credit event. Debt level is just one of them.

Why a Possible Black Swan Event in 2014?

I say that I expect a black swan event to occur that will affect the Phisix-ASEAN and perhaps or most likely the world markets and economies.

The black swan theory as conceived by Mr. Taleb has been founded on the idea that a low probability or an ‘outlier’ event largely unexpected by the public which ‘carries an extreme impact’ from which people “concoct explanations for its occurrence after the fact”[22]

The Turkey Problem signifies the simplified narrative of the black swan theory[23]. 

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A Turkey is bought by the butcher who is fed and pampered from day 1 to day 1000. The Turkey gains weight through the feeding and nurturing process as time goes by.

From the Turkey’s point of view, the good days will be an everlasting thing. From the mainstream’s point of view “Every day” writes Mr. Taleb “confirms to its staff of analysts that Butchers love turkeys “with increased statistical confidence.””[24]

However, to the surprise of the Turkey on the 1,001th day or during Thanksgiving Day, the days of glory end: the Turkey ends up on the dinner table.

For the Turkey and the clueless mainstream, this serves as a black swan event, but not for the Butcher.

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For me, the role of the butcher will be played by rising interest rates amidst soaring record debt levels.

Global public and private sector debt from both advanced economies and emerging has reached $223 trillion or 313% of the world’s gdp as of the end of 2012[25]. This must be far bigger today given the string of record borrowings in the capital markets for 2013, especially in the US (see below).

Moreover, recent reports say that there will be about $7.43 trillion of sovereign debt from developed economies and from the BRICs that will need to be refinanced in 2014. Such ‘refinancing needs’ account for about 10% of the global economy which comes amidst rising bond yields or interest rates[26].

While I believe that the latest Fed tapering has most likely been symbolical as the outgoing Fed Chair’s Ben Bernanke may desire to leave a legacy of initiating ‘exit strategy’ by tapering[27], the substantially narrowing trade and budget deficits and the deepening exposure by the Fed on US treasuries (the FED now holds 33.18% of all Ten Year Equivalents according to the Zero Hedge[28]) may compel the FED to do even more ‘tapering’. 

Such in essence may drain more liquidity from global financial system thereby magnifying the current landscape’s sensitivity to the risks of a major credit event.

And unlike 2009-2011 where monetary easing spiked commodities, bonds, stocks of advanced and emerging markets, today we seem to be witnessing a narrowing breadth of advancing financial securities. Only stock markets of developed economies and of the Europe’s crisis afflicted PIGS and a few frontier economies appear to be rising in face of slumping commodities, sovereign debt, BRICs and many major emerging markets equities. This narrowing of breadth appears to be a periphery-to-core dynamic inherent in a bubble cycle thus could be seen as a topping process.

Meanwhile the Turkey’s role will be played by momentum or yield chasers, punters and speculators egged by the mainstream worshippers of bubbles and political propagandists who will continue to ignore and dismiss present risks and advocate for more catching of falling knives for emerging markets securities.

And the melt-up phase of developed economy stock markets will be interpreted by mainstream cheerleaders with “increased statistical confidence”.

The potential trigger for a black swan event for 2014 may come from various sources, in no pecking order; China, ASEAN, the US, EU (France and the PIGs), Japan and other emerging markets (India, Brazil, Turkey, South Africa). Possibly a trigger will enough to provoke a domino effect.

I will not be discussing all of them here due to time constraints

Bottom line: the sustained and or increasing presence of the bond vigilantes will serve as key to the appearance or non-appearance of a Black Swan event in 2014.

As a side note: the dramatic fall on yields of US Treasuries last Friday due to lower than expected jobs, may buy some time and space or give breathing space for embattled markets. But I am in doubt if this US bond market rally will last.

[update: I adjusted for the font size]



[1] See What to Expect in 2013 January 7, 2013




[5] George Soros The Alchemy of Finance John Wiley & Sons page 58, Google Books


[7] Nassim Nicolas Taleb Antifragile: Things That Gain from Disorder Random House New York, p.9 Google Books




[11] Bangko Sentral ng Pilipinas Annual Report 2012 p.50


[13] Domini M. Torrevillas Garbage collectors are now SSS members Philstar.com October 17, 2013

[14] Government Service Insurance System GSIS prepares for UMID-compliant eCard enrollment







[21] World Bank EAST ASIA AND PACIFIC ECONOMIC UPDATE Rebuilding Policy Buffers, Reinvigorating Growth October 2013 p.46



[24] Nassim Nicolas Taleb Op. cit p93

[25] Wall Street Real Time Economics Blog Number of the Week: Total World Debt Load at 313% of GDP May 11, 2013



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Monday, July 22, 2013

Phisix: The Myth of the Consumer ‘Dream’ Economy

Life is not about self-satisfaction but the satisfaction of a sense of duty. It is all or nothing. Nassim Nicholas Taleb

The Bernanke Put: If we were to tighten policy, the economy would tank
I don't think the Fed can get interest rates up very much, because the economy is weak, inflation rates are low. If we were to tighten policy, the economy would tank.
That’s from Dr. Ben Bernanke, US Federal Reserve Chairman’s comment during this week’s Question and Answer session in the congressional House Financial Services Committee hearing[1].

This practically represents an admission of the entrenched addiction by the US and the world financial markets on the central bank’s sustained easy money policy. This has likewise partially been reflected on the US and global economies. I say “partially” because not every firms or enterprises use leverage or financial gearing from banks or capital markets as source of funding operations. Since I am not aware of the degree of actual leverage exposure of each sector, hence it would seem to use “safe” as fitting description to the aforementioned relationship.

The fundamental problem with easy money dynamics is that these have been based on the promotion of unsound or unsustainable debt financed asset speculation and debt financed consumption activities, in both by the private and in the government, in the hope of the trickle down multiplier from the “wealth effect”.

The reality is that such policies does the opposite, it skews the incentives of economic activities towards those subsidized by the government particularly financial markets, banks, and the government (via treasury bills, notes and bonds as low interest rates enables sustained financing of the expansion of government spending) which widens the chasm of inequality between these politically subsidized sectors at the expense of the main street. For these sectors, FED’s easy money policies signify as privatization of profits and socialization of losses.

Yet the massive increases in debt as consequence from such loose interest rate policies, magnifies not only credit risk, thus affecting credit ratings or creditworthiness, but importantly the diversion of wealth from productive to capital consuming activities, which ultimately means heightened interest rate and market risks.

Eventually no matter how much money will be injected by central banks, if the pool of real savings will get overwhelmed by such imbalances, then interest rates will reflect on the intensifying scarcity of capital.

Capital cannot simply be conjured by central bank money printing, as the great Ludwig von Mises warned[2] (bold mine)
The inevitable eventual failure of any attempt at credit expansion is not caused by the international intertwinement of the lending business. It is the outcome of the fact that it is impossible to substitute fiat money and a bank's circulation credit for capital goods. Credit expansion can initially produce a boom. But such a boom is bound to end in a slump, in a depression. What brings about the recurrence of periods of economic crises is precisely the reiterated attempts of governments and banks supervised by them, to expand credit in order to make business good by cheap interest rates.
From such premise, interpreting “low” interest rates as a function of “weak” economy and “low” inflation seems relatively inaccurate.

Such assessment has been based on the rear view mirror. As of Friday, Oil (WTIC) at US $108 per bbl and gasoline at $ 3.12 per gallon, as noted last week[3] US producer prices have also been rising, which reflects on an inflationary boom stoked by credit expansion. If energy and commodity prices persist to rise, then “low” price inflation will transform into “high” price inflation. Thus “price” inflation, as corollary to monetary inflation, will likely add pressure on bond yields and interest rates.

Moreover record levels of US stock markets imply of intensifying asset inflation. Prior to the bond market turmoil, US housing has also caught fire. “Low” levels of price inflation or what mainstream sees as “stable prices” doesn’t imply of the dearth of accruing imbalances, on the contrary, these are signs of the boom bust cycle in motion channeled through specific industries, similar to the “roaring twenties[4]” or the US 1920s bubble and the 1980s stock and property bubble in Japan.

As the great dean of the Austrian school of economics, Murray N. Rothbard explained of the inflating bubble of 1920s amidst low price inflation[5]:
The trouble did not lie with particular credit on particular markets (such as stock or real estate); the boom in the stock and real-estate markets reflected Mises's trade cycle: a disproportionate boom in the prices of titles to capital goods, caused by the increase in money supply attendant upon bank credit expansion
The same bubbles on “titles to capital goods”, via stocks and real estate, plagues from developed economies to emerging markets, whether in Brazil, China or ASEAN.

And “weak” economy in the backdrop of elevated levels of interest rates powered by price inflation had been a feature of the stagflation days of 1970s.

Finally, while price inflation, scarcity of capital and deterioration of credit quality are factors that may lead to higher interest rates as expressed via rising bond yields, another ignored factor has been the relationship between the growth of money supply and interest rates.

As Austrian economist Dr. Frank Shostak explains[6]
an increase in the growth momentum of money supply sets in motion a temporary fall in interest rates, while a fall in the growth momentum of money supply sets in motion a temporary increase in interest rates.

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Such momentum based relationship can be seen in the Fed’s M2 and the yield 10 year constant maturity or even with the Divisia money supply

On the top pane, in 2008-2010, as the Fed’s M2 (percent) simple sum aggregate (blue line) collapsed, the yields (percent change from a year ago) of 10 year constant maturity notes soared. Following the inflection points of 2010, the relationship reversed, particularly the M2 soared as the Fed’s 10 year yields fell.

The M2 commenced its decline on the 1st quarter of 2012 while the UST 10 year yield rose in July or with a time lag of over three months.

The Divisia money supply, instead of a simple sum index used by central banks, is a component weighted index which has been based on the ease of, and opportunity costs of the convertibility or “moneyness” of the component assets into money (Hanke 2012)[7].

The Divisia money supply has been invented by invented by François Divisia, 1889-1964 and has now been made available via the Center for Financial Stability (CFS) in New York, through Prof. William A. Barnett[8]

As of June[9], the varying indices of the Divisia money supply based on year on year changes have all trended downwards since late 2012.

The slowdown in the growth of momentum of money supply have presently been reflected on the upside actions of yields of the bond markets.

The momentum of changes of money supply will largely be determined by the rate of change of credit conditions of the banking system.

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Rising bond yields largely attributed to the FED’s “tapering” chatter has spurred a huge $66 billion in the past 5 weeks through July exodus on bond market funds according to Dr. Ed Yardeni[10].

The destabilizing rate of change in bond flows appear as evidence of “If we were to tighten policy, the economy would tank”

Bernanke PUT’s Effect: Parallel Universes

The Q&A statement along with the Dr. Bernanke’s earlier comments in the House Financial Services Committee where he said central bank’s asset purchases “are by no means on a preset course[11]” has energized a Risk ON environment.

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US stocks broke into record territories. Benchmarks of several key global stock markets rebounded. Global bond markets (yields) rallied along with commodity prices.

During the past two weeks, the financial markets have been guided higher by repeated assurances from Dr Bernanke aside from central bankers of other nations.

Given this cue, ASEAN stock and bond markets rallied substantially despite what seem as deteriorating fundamentals.

The sustained rout of the Indonesia’s rupiah appears to have been ignored by the stock and bond markets. Indonesia’s central bank, Bank Indonesia intervened in the currency market by injecting dollars into the system. Indonesia’s foreign exchange reserves dropped by $7.1 billion in June, the most since 2011, and which brings total reserves to less than $100 billion, a first in two years, according to a report from Bloomberg[12].

Indonesia’s unstable financial markets mainly via the bond and currency have prompted the World Bank to cut her growth forecast early June. Thailand’s central bank have downshifted their economic growth estimates along with their Ministry of Finance and the IMF[13].

The IMF has also marked down global economic growth due to “longer economic growth slowdown”[14], from China and other emerging economies whom have been faced with “new risks”

The Asian Development Bank (ADB) has also trimmed growth forecast for ASEAN at 5.2% where the Philippines has been expected to grow 5.4% in 2013 and 5.7% 2014[15].

In contrast to the ADB, the IMF, whom downgraded world economic growth, has upgraded economic growth projection of the Philippines to 7% in 2013[16]
In the world of central bank inflationism, “fundamentals” in the conventional wisdom hardly drives the markets. Stock and bond markets may substantially rise even as the economy has been mired in a prolonged period of negative growth or recession. This has been in the case of France in 2012-13[17].

An investor in Chinese equities would have only earned 1% per year during the last 20 years even as per capita has zoomed by 1,074 percent over the same period, according to a Bloomberg report[18].

This shows how the discounting mechanism of financial markets has been rendered broken, relative to reality, reinforced by the stultifying effects of central bank easing policies.

And amidst sinking stock markets and the recent spike in short term interbank interest rates due to supposed cash squeeze from attempts by the Chinese government to ferret out and curtail the shadow banks, China’s increasingly unstable and teetering property bubble continues to sizzle with home prices rising in 69 out of 70 cities. Guangzhou, Beijing and Shanghai reported their biggest gains since the government changed its methodology for the data in January 2011 according to another report from the Bloomberg[19].

Such dynamics reinforces China’s parallel universe

Never mind that Chinese rating agencies downgraded “the most bond issuer rankings on record in June” as brokerage houses have been preparing for “the onshore market’s first default as the world’s second-biggest economy slows” according to another Bloomberg article[20].

China’s rampaging property bubble appears to be in a manic blow-off top phase

The Myth of the Consumer ‘Dream’ Economy

Speaking of mania, a further manifestation of the “permanently high plateau”, new order, new paradigm, “this time is different” can be seen from the president of the Government Service Insurance System Robert Vergara, who proclaims that the Philippines has reached a political economic nirvana.

From a Bloomberg report[21]:
The country “is still experiencing a secular growth story,” Vergara said. “We have the kind of economy that every country dreams of.”
Being an appointee of the Philippine president[22] it would seem natural to for him to indoctrinate or propagandize the public on the supposed merits of the current boom as part of the PR campaign for the government.

The GSIS president says he expects a return of 9% or more for the Philippine equity benchmark, the Phisix, over the next 12 months, as earnings will increase by about 15% during the next two years. All these have been premised on the ‘dream’ Philippine economy which he projects as expanding by 6-7% during the next 2 years and whose growth will be anchored by record-low interest rates which allegedly will fuel consumer spending.

What has been noteworthy in the reported commentary has been that of the GSIS’s president implied market support for local equities, where “the fund would consider increasing equity holdings to as much as 20 percent of total assets if the gauge falls below the 5,500 level”. If a private sector investor will say this they will likely be charged with insider trading.

And if he is wrong, much the retirement benefits of public servants risks being substantially diminished. Otherwise, taxpayers will be compelled to shoulder such imprudent actions.

But has the Philippine economy been driven by consumer spending as popularly held?

According to the National Statistical Coordination Board’s 1st quarter GDP report[23]:
With the country’s projected population reaching 96.8 million in the first quarter of 2013, per capita GDP grew by 6.1 percent while per capita GNI grew by 5.3 percent and per capita Household Final Consumption Expenditure (HFCE) grew by 3.4 percent. – 

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The same Philippine economic agency notes that based on the 1st quarter expenditure share of statistical economic growth, household final expenditure grew by only 5.1% (left pane). This has been less than the 7.8% overall growth rate of the economy.

Merchandise trade had hardly been a factor as exports posted negative growth while imports had been little changed. Government final expenditure grew by more than double the rate of household final expenditure or by 13.2%, and capital formation had been mostly powered by construction up by 33.7%.

From the industrial origin calculation perspective (right pane) we see the same picture. Construction soared by an astounding 32.5%. This has fuelled the Industry sector’s outperformance, which had been seconded by manufacturing 9.7%. Financial intermediation has also registered a strong 13.9% which undergirded the service sector. Public administration ranked fourth with 8% growth, about the rate of the nationwide economic growth.

So data from the NSCB reveals that during the 1st quarter, statistical growth has hardly been about the household consumption spending driven growth, but about the massive supply side expansion as seen through construction, financial intermediation, and secondly by government expenditures.

Yet here is what the Philippine ‘dream’ economy has been made up of.

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Credit growth underpinning the fantastic expansion of the construction industry has been at a marvelous or breathtaking rate of 51.19% during the said period, this is according to the data from the Bangko Sentral ng Pilipinas as I previously presented[24].

How sustainable do you think is such rate of growth?

Meanwhile, bank lending to financial intermediation and real estate, renting and business services and hotel and restaurants grew by a whopping 31.6%, 26.24% and 19.18%, respectively. Wholesale and retail trade grew by 12.49%.

Banking loans to these four ‘bubble’ sectors which embodies the shopping mall, vertical (office and residential) properties, and state sponsored casinos accounts for 53.25% of the share of total banking loans.

Remember household final demand grew by a relative measly 5.1% and this partly has been backed by bank lending too. Bank lending to the household sector grew a modest 11.89% backed by credit card and auto loans 10.62% and 13.86%. Only 4% of households have access to credit card according to the BSP.

The explosive growth in bank credit can be seen both in the supply and demand side. But the supply side’s growth has virtually eclipsed the demand side.

So based on the 1st quarter NSCB data the Philippine consumer story (provided we are referring to household consumers) has been a myth.

Basic economic logic tells us that if the supply side continues to grow by twice the rate of the demand side, then eventually there will be a massive oversupply. And if such oversupply has been financed by credit, then the result will not be nirvana but a catastrophe—a recession if not a crisis.

Given the relentless growth in credit exactly to the same sectors during the two months of April-May, statistical GDP growth will likely remain ‘solid’ and will likely fall in the expectations of the mainstream. The results are likely to be announced in August.

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Prior to the Cyprus crisis of 2013, many Cypriots came to believe that this “time is different” from which many hardly saw the potential impact from a sudden explosion of public sector debt[25]

Unfortunately, a populist dream morphed into a terrifying nightmare.

BSP’s Wealth Effect: San Miguel as Virtual Hedge Fund

And for the moral side of the illusions of dream economy tale, given that only 21.5 of every 100 households have access to the banking sector, and as I previously explained[26], where domestic credit from the banking sector accounted for 51.54% of the GDP as of 2011, and also given that the wealthy elites control some 83% of the domestic stock market capitalization and where the residual distribution leaves 15-16% to foreigners while the rest to the retail participants, an asset boom prompted by BSP zero bound policy rates represents a transfer of wealth from the rest of society (most notably the informal sector) to the political class and their politically connected economic agents. 

This should be a good example.

Publicly listed San Miguel Corporation [PSE: SMC] recently sold their shareholdings at Meralco for $399 million[27] to an undisclosed buyer.

The BSP inspired Philippine asset boom has transformed San Miguel from an international food and beverage company into a virtual hedge fund which profits from trading financial securities of the highly regulated sectors of energy, mining, airlines and infrastructure.

The 32.8% sale of Manila Electric or Meralco [PSE: MER] and the prospective 49% sale of another SMC asset, the SMC Global Power Holdings, reportedly the country’s largest electricity generator with assets accounting for a fifth of the nation’s capacity, has been expected to raise at least $1.6 billion[28], according to a report from Bloomberg

SMC sales of its Meralco holdings extrapolate to a huge windfall. According to the same report, SMC has tripled return on equity from its conversion to heavy industries.

Moreover, SMC has acquired about 40 companies for about $8 billion which has been partly funded by leverage where “the company and its units have 272 billion pesos worth of debt due by 2018 and San Miguel has 152 billion pesos in cash and near-cash items, the data show.”

Asked by a reporter about the prospects of the sale, the SMC’s President Mr. Ramon Ang bragged “Does San Miguel need the money? No. We can always borrow to fund any opportunity.”

Obviously, a reply based on easy money conditions.

As explained in 2009, the radical makeover of San Miguel has been tinged by politics[29]. The energy, mining, airlines and infrastructure which the company has shifted into are industries encumbered by politics mostly via anti-competition edicts. Thus asset trading of securities from these sectors would not only mean profiting from loose money policies, but also from also arbitraging economic concessions with incumbent political authorities.

The viability of these sectors particularly in the energy and infrastructure (roads) are endowed or determined by political grants. For instance in the case of Meralco, the Office of the President indirectly determines the “earnings” of the company via the price setting and regulatory oversight functions of the Energy Regulatory Commission which is under the Office of the President[30]. The private sector operator of Meralco has to be in good terms, or has blessing of, or has been an ally of the President. These are operations which can’t be established by analysing financial metrics for the simple reason that politics, and not, the markets determine the company’s feasibility.

San Miguel’s new business model allows political outsiders to get into these economic concessions through Mr. Ang’s political intermediations which it legitimately conducts via “asset trading”. SMC’s competitive moat, thus, has been in the political connections sphere.

SMC has also been a major beneficiary from the BSP’s wealth effect and wealth transfer from zero bound rates and from the Philippine government’s highly regulated or politicized industries.

Nonetheless leverage build up for asset trading necessitates a low interest rate environment. Should interest rates surge, and asset markets fall, Mr. Ang’s $35 billion dream might turn into an unfortunate Eike Batista[31] story.

Mr. Batista, the Brazilian oil, energy, mining and logistics magnate was worth $34 billion and had been the 8th richest man in the world a year ago.

Mr. Batista’s highly leveraged or indebted companies crashed to earth when commodity prices collapsed, and exposed such vulnerabilities. Debt deleveraging likewise uncovered the artificial wealth grandeur which has been embellished by debt.

Mr. Batista’s debt fiasco reduced his fortune to only $2 billion. At least he remains a billionaire.

Yet given his political connections, Mr. Ang may expect a bailout from his political patrons.

Risks remain high. Do trade with caution


[2] Ludwig von Mises Theory of Money and Credit p.423


[4] Wikipedia.org Roaring Twenties

[5] Murray N. Rothbard, The Lure of a Stable Price Level, America’s Great Depression Mises.org September 13, 2011

[6] Frank Shostak, What Next for Treasury Bonds? May 03, 2010

[7] Steve H. Hanke, Rethinking Conventional Wisdom: A Monetary Tour d’Horizon for 2013, Energy Tribune January 23, 2013

[8] Wikipedia.org Divisia index

[9] Center for Financial Stability CFS DIVISIA MONETARY DATA FOR THE UNITED STATES, July 17, 2013

[10] Ed Yardeni Great Rotation? (excerpt) Yardeni.com July 16, 2013





[15] Business Mirror ADB cuts growth forecast for Asean July 17, 2013







[22] Wikipedia.org Government Service Insurance System Organizational Structure

[23] National Statistical Coordination Board, Highlights Philippine Economy posts 7.8 percent GDP growth May 30, 2013


[25] John Mauldin The Bang! Moment Shock Advisor Perspectives.com July 13, 2013


[27] Wall Street Journal Money Beat Blog San Miguel Raises $399.5 Million via Sale of Meralco Shares July 18, 2013




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