October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard—Alan Greenspan

In this issue

October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

-Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risks of a Fiscal Crisis

-How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics

-The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation

-The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?

October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risk of a Fiscal Crisis

Figure 1

With 10-months through 2018, the National Government’s (NG) fiscal deficit zoomed to Php 483.1 billion as public spending outpaced collections immensely. The 10-month deficit has raced 25% above last year’s annual rate with two months to go! (figure 1 upper window)

Though revenues recovered to jump by 20.33% year-on-year from September’s 1.13%, public expenditure growth sizzled at 35.16% in October from 26% a month ago. As such, October deficit more than doubled (174%) at Php 59.87 billion from 2017’s Php 21.8 billion.

The Bureau of Internal Revenue (BIR) collection growth bounced 15.61% in October from the -7.68% it registered in September. It was, however, revenues from the Bureau of Customs (+30.38%) and Non-Tax Revenues (+31.97%) that provided the main boost for the total revenue growth in October. BIR, BoC and Non-tax revenues had a revenue share of 66.78%, 22.67% and 9.93% of the total.

Following its peak in late 2017, tax revenue growth has been decelerating in line with the slowdown in the growth of total bank loans. The bounce in tax revenues in October appears to have echoed the rebound in the bank loans (+18.36%) in the same month from 17.42% in September and 18.83% in August.

Figure 2

In the 10 months, 2018’s total collection growth of 17.53% was the second highest since 2011’s 17.88%. However, despite a broader tax base and substantial increases in excise taxes, BIR collection growth of 11.6% trailed marginally 2016’s 11.69%, and lagged widely 2014’s 18.84%, 2013’s 20.36%, 2012’s 11.99% and 2011’s 14.29%. 

Again, much of the growth in total revenues have been from collections by the BoC from the record imports that has brought about unprecedented trade deficits, and from non-tax revenues. And record imports have been much about public and private sector spending related to build, build and build. To this end, the government’s aggressive deficit spending produced a twin deficit: trade and fiscal deficit.

It is for this reason that TRAIN 2.0, from the perspective of the NG, must be onboarded.

NG collections would have to be kept at a targeted level to sustain the projected rate of fiscal deficit. Otherwise, a shortfall in total collections would unexpectedly widen the fiscal gap thereby requiring a disproportionate amount of funding.

And the risk of a fiscal crisis increases in the event of an unanticipated blowout in the spending-revenue gap.  “Fiscal crisis” is a term coined by James O'Connor who denoted of a “structural gap” between public revenues and expenditures that leads to an economic, social and political crisis (encyclopedia.com).

Though studies like the IMF observed the emergence of such crises based on plummeting growth and unemployment and or a surge in inflation; from my perspective, the financing the gap should be more of a concern.  Access to local savings through the banking system, domestic and international capital markets will play crucial roles in the bridge financing of the accretion of such deficits. 

The 10-month data tells us that the escalation in public spending rather than a shortfall of revenues has engendered such a historic deficit.

As such, the aggressive pace of public spending has resulted in the government’s direct share of the estimated 10-month GDP to surge to 20.18%, the highest ever since 1986. Such figures exclude indirect expenditures or private sector spending on public projects (such as Public-Private Partnerships or PPPs).

Such frenzied rate of public spending ventilated through unmatched deficits reveals of the structural shift in the growth model of the Philippine political economy.

The Philippines has rapidly been moving away from a market economy and has transitioned to a socialist (state) economy, patterned after China. The neo-Maoist model.

And since government spending means competition for resources and funding, the bigger the share of the government, the lesser resources and funds are made available to the private sector. And with a lesser output from the diversion of funding and resource consumption to the government, street prices can be expected to rise, as it has.

How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics

How does one model or analyze such a transition? The shift towards political directed economic activities would render financial ratios, like PE, Price to Sales, ROIC and etc., obsolete!

For instance, instead of business viability, the principal determinant of credit quality would be about political connections. 

Politically instituted monopolies would emerge as a result of business barriers and the political picking of winners and losers.

Legislative bills purportedly aimed to “open” the economic backdrop to a business-friendly environment would be all a sham for as long as the government continues to shanghai the economy’s resources and finances.

Moreover, sustained intrusion through various political channels such as regulations, mandates, licenses, prohibitions, taxation and more, cements the control of the economic sphere by politicians, bureaucrats and special interest groups.  

It’s like the alleged deregulation of the Telecom industry in 1995 (RA 7925) which ended up with an oligopolistic structure, primarily because of operational interventions. Yes, on the surface, the government deregulated the industry, but the stranglehold of the industry increased resulting in the elimination of competitors by operational interventions.

And the same politically determined operational obstacles have been used to displace alleged competition to usher in the entry of China Telecoms as the third player last month. Fitch Solutions wrote: “The selection of China Telecom, which follows the almost immediate disqualification of the two other bidders, hints at the government’s bias towards Chinese involvement in the telecoms sector, and is a clear sign of Duterte’s warming posture towards China.”  It was more than a bias, it was a setup. [See Has the Choice for the Third Telco Player Been Rigged? Will a National Social Credit System be the Next Telecom Agenda? (November 11, 2018)]

As the web of political control expands over the economic sphere, the distribution of economic opportunities would become more politicized at the expense of the marketplace.

Even the allocation of banking loans has become slanted towards industries favored or controlled by the NG.

Figure 3

Bank loans to the politically favored or controlled sectors grew robustly as these were the principal contributors to the improvement in bank lending in October, namely construction (39.08% in October, 37.04% in September), public administration and defense (28.19% and 27.52%), education (25.95% and 23.86%) and financial intermediation (32.01% and 31.01%). Only loan growth to the transport industry fell 17.73% and 22.03%.

Of course, there will always be a tradeoff. The opportunity costs of rewarding political sectors come at the expense of the consumers. Bank loan growth to the retail sector slipped to +19.91% in October from 22.71% in September and have now caught up with the sharp downturn in consumer loans +14.61% in October and 18.19% a month ago.

If the growth of cash in circulation (m1) collapsed in October (+8.92% from +11.4% a month ago) and where credit card spending slowed (+21.6% and +22.2%), how did consumers finance their spending? Salary loans continued to contract for four straight months!

The consumer economy paid the price of redistributing benefits to the political and politically affiliated sectors.

So what should happen to the frenetic race-to-build supply for the consumers?

The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation

However, there is no such thing as a free lunch.

The political spending elixirs that should serve as the nation's economic deliverance requires funding.  

Thus, spend, spend and spend has been supported by a mixture of debt and the BSP’s monetization.

Figure 4

An update of the public debt data has yet to be published by the Bureau of Treasury.

Nevertheless, debt servicing of public debt swelled to Php 649.72 billion running at a rate to reach possibly the record high of Php 854.374 billion in 2006. The share of debt servicing to revenues jumped from a record low of 19.83% in the year 2017 to 27.55% in the 10-months of 2018.

With the burgeoning amount of debt supported by increasing interest rates, debt servicing can be expected to keep moving in pace with the record growth of deficits. One of the carrying cost to the economic deliverance from spend, spend and spend elixir would be the deepening leveraging of the taxpayer’s balance sheet and its attendant risks.

For as long as there will be access to credit or someone’s savings or income (via tax), the spending panacea can go on.

Naturally, the NG can’t use an all debt financing because it would siphon away liquidity in the private sector. If the private sector, the principal source of funding gets drained, from where will they get funding? That’s the reason why central banks exist.

To leave some crumbs to the private sector, the BSP assumes the other role of providing finance to the intensifying public sector spending.

From the BSP’s October domestic liquidity report: “Net claims on the central government grew by 11.3 percent in October, broadly steady from 11.4 percent (revised) in the previous month.”

The BSP allotted Php 17.09 billion in October for a 10-month aggregate of Php 207 billion or about 47.25% of the total deficit during the said period, the second largest amount of monetization by the BSP since 2015. The BSP launched its version of Quantitative Easing in 2015.

So the other carrying cost to the economic deliverance from spend, spend and spend elixir would be to inflate the system at which comes at the sacrifice of the peso, or the citizen’s purchasing power

The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?

The 10-month record deficit of Php 483.1 billion is just Php 40.5 billion shy from the NG's target of Php 523.6 billion

Christmas spending such as the published Php 25k bonus to government employees and other yearend earmarks can easily push such deficit beyond the official annual target.

Revenue conditions will play a critical role. If collections underperform in the face of programmed increases in expenditures, deficits will be pushed further away from the target. That said, how the NG finances this will be projected into the interest rates, the CPI, debt levels, the economy, and earnings.

So far, in the thrust to finance the record NG deficit and to clamp down on the CPI, the BSP has been tightening liquidity in the system directed at the private sector. The sharp fall of M3 and consumer credit demonstrates such transfer as shown above.

While tax collections have held ground in October, the effect of such tightening may lag.

In the last twenty years, deficit-to-NGDP ratios of over 3% occurred during downturns in revenues as an outcome of economic slowdown.

And public expenditures were ramped up in only times of economic stress, such as the Economic Resiliency Plan (ERP) in 2009, put in place as a stabilizing force against the Great Recession. Part of the ERP was the transitory Php 330 billion fiscal stimulus (4.1% of GDP)

A gradual withdrawal of fiscal stimulus segued as the economy gained momentum.

As I have been saying here, this time is different.

Fiscal stimulus used against adverse external influences has become the principal development model used to attain economic growth. The former, known as Keynesian economics, has been reinvented.

At the end of 2018, fiscal deficit should breach past 3% of GDP target even with the headline GDP hovering at 6% and above. (chart shows 1986-2017 only). Again, traditionally, 3% deficit to NGDP ratio coincided with falling real GDP. Not today.

The Philippine economy has been surviving on emergency measures via monetary stimulus (record QE, record low interest rates) and unprecedented fiscal stimulus.

Diminishing returns from these measures have become apparent even when no downturn or crisis has yet transpired. The peso has fallen, market rates, as well as, policy rates have increased and debt continues to mount.

Remember this? (FSCC’s FSR 2017)

While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise.

What policy tools would be left for our policymakers to use, should a genuine shock (whether of internal or external origin) occur?

Quote of the Day: The Entire Case for Keynesianism is Based on this Slogan

The Keynesians have no equivalent of this slogan: "There is no such thing as a free lunch." This is a powerful slogan. So is this one: "You can't get something for nothing." So is this one: "If it sounds too good to be true, it probably is." So is this one: "Honesty is the best policy." But, above all others, we have this one: "Thou shalt not steal."

The Keynesians have this slogan: "I'm from the government, and I'm here to help you." The entire case for Keynesianism is based on this slogan.

This is why it pays to defend freedom. Even when the overwhelming majority of voters do not want to hear the arguments, we should keep making them. We should keep pointing out that there will be horrendous negative repercussions for violations of the principle of voluntary exchange. We don't get a hearing, except during crises. I have good news. There will be plenty of crises in which we will get a hearing.

This excerpt is from Austrian economist Gary North from his (recommended  read) article "Have Hope: Our Opponents Are Economic Imbeciles"

Infographics: Keynesian Economics 101

If one should wonder why the scourge of boom busts cycles and its attendant crises (economic, financial, currency and debt), as well as accounts of hyperinflation, continually afflicts society, then look no further than to the economic dogma that has provided justification for their existence.

The Austrian Insider (hat tip Mises Blog and Zero Hedge) on the 4 Simple Lessons of Keynesian economics

Since Keynesian economics has reined supreme among mainstream economists for decades, you might want to know some of the basics. If this is confusing to you though, don’t worry about it! There are people in charge who have it all under control.

The great Austrian economist F.A. Hayek on Keynesian economics (from page 349 of Hayek’s The Trend of Economic Thinking, which is Vol. 3 in The Collected Works of F.A. Hayek hat tip Cafe Hayek) [bold added]

It is characteristic of much of recent economics that by ever new arguments it has tried to vindicate those very prejudices which are so attractive because the maxims that follow from them are so pleasant or convenient: spending is a good thing, and saving is bad; waste benefits and economy harms the mass of the people; money will do more good in the hands of the government than in those of the people; it is the duty of government to see that everybody gets what he deserves; and so on.)

Why Keynesian economics have popular with politicians and why it signifies as societal disease. From Austrian economist Peter Boettke (bold added)  

Keynesianism is not a panacea because Keynesianism has dominated public policy making for half a century and has left us in such a state of public debt. Keynesianism broke the old time fiscal religion of balanced budgets and fiscal responsibility, and changed not only attitudes of economists and policy makers, but also eroded whatever institutional constraints existed on public spending that had existed. Keynesianism cannot work to solve our current problems because Keynesianism is responsible for our current problems. Keynesianism provided an illusion of short term prosperity, but the reality of long term stagnation. Of course, the revealing of the illusion can be put off, as I have pointed out before, if there is the discovery of new opportunities for gains from trade, and/or gains from innovation.

But the governmental habit of spending is still there and the bill has to be paid as some point. Keynesianism is a disease on the body politic because it caters to the natural propensity of politicians to focus on short run, and to concentrate benefits and disperse costs.

Christopher Casey: GDP is Designed to Advance the Keynesian Interventionist Agenda

My third and last post on 'GDP week'.

At the Mises Institute, Christopher Casey writes that GDP (statistical G-R-O-W-T-H) has represented an economic tool (designed by Keynesians) to justify political interventionism (bold mine; footnote omitted)

GDP purports to measure economic activity while largely divorcing itself from the quality, profitability, depth, breadth, improvement, advancement, and rationalization of goods and services provided.

For example, even if a ship — built at great expense — cruised without passengers, fished without success, or ferried without cargo; it nevertheless contributed to GDP. Profitable for investors or stranded in the sand; it added to GDP. Plying the seas or rusting into an orange honeycomb shell; the nation’s GDP grew.

Stated alternatively, GDP fails to accurately assess the value of goods and services provided or estimate a society’s standard of living. It is a ruler with irregular hash marks and a clock with erratic ticks.

As proof, observe this absurdity: in 1990, Soviet GDP equaled half of US GDP, according to the 1991 CIA Factbook. No one visiting the Soviet Union in 1990 would believe their economy came close to 50 percent of the quality and quantity of the goods and services produced in America. GDP-defined production may have been strong, but laying roads to nowhere, smelting unusable steel, and baking barely edible breads stretches the definition of “production.” And this describes the goods which were actually produced. There is no accounting for the opportunity cost of forfeited essential goods and services.

How can this be? Why does GDP poorly reflect economic size and vitality? The blame largely resides with three fallacious concepts embedded within GDP “measurements”:

(1) intermediate goods (e.g., steel) must be eliminated to avoid “double counting”;

(2) government expenditures consist of viable economic activities; and

(3) imports should be netted against exports.

The Overstatement of Consumption

Which transactions should be included within GDP? Since most products consist of other products, GDP architects attempt to avoid “double counting” transactions by largely including only final goods and services produced. By their methods, the production of a car is counted (as an increase in inventory), but the metal, rubber, and plastic purchased in its creation is not. But the rules behind what makes a transaction “final” are arbitrary. The logic could just as easily justify including the sale of an automobile to a consumer and disregarding its previous production. In addition, any “final” transaction during a given time period does not necessarily include intermediate goods produced in that same time period: metal, rubber, and plastic purchased today will likely be for a different car produced or sold in a different (future) time period.

Regardless as to the arbitrary nature of determining final sales and notwithstanding the problem of temporally matching intermediate goods with their associated final sales, the exclusion of certain “intermediate” transactions simply excludes massive volumes of economic activity. Thus, GDP understates the economy as a whole while grossly overstating its consumption component relative to business investment. A better measure of overall production was created in 2014 when the US Commerce Department began publishing Gross Output which incorporates intermediate transactions. Using Gross Output, the commonly cited statistic of consumption accounting for 70 percent of all economic activity quickly falls to a mere 40 percent. 

The Treatment of Government Expenditures as Productive

If GDP purports to measure economic activity which benefits society, the inclusion of government expenditures is dubious. GDP “produced” in the Soviet Union is no different than GDP “produced” by any government — the difference is but one of scale. All government spending is to some degree malinvestment, for as Murray Rothbard noted:

Spending only measures value of output in the private economy because that spending is voluntary for services rendered. In government, the situation is entirely different ... its spending has no necessary relation to the services that it might be providing to the private sector. There is no way, in fact, to gauge these services.

The absence of voluntary action renders prices impotent, and without true price discovery, benefits cannot be ascertained. This does not mean all goods and services provided by government would cease to exist; rather, some production (e.g., hospitals, schools, roads, etc.) would revert to the private sector. To the extent government expenditures for goods and services would be produced by the free market, the true government contribution to GDP may be positive but overstated (it currently approximates 20 percent of US GDP). A more accurate depiction of economic activity would reduce if not eliminate the contribution of government expenditures. Or perhaps, as Rothbard argued, the higher of government receipts or expenditures should actually be deducted from GDP since “all government spending is a clear depredation upon, rather than an addition” to the economy.

The Problems of Subtracting Imports from Exports

As Robert Murphy has noted several times, the netting of imports against exports in determining GDP seriously understates the contribution of trade to overall economic activity. To wit, an economy which exports $1 and imports $1 will have the same GDP contribution (zero) as one which exports $100 billion and imports $100 billion. Obviously, the latter economy would be far worse off with the sudden cessation of trade.

A fixture of GDP is the mercantilist mentality of treating exports positively and imports negatively. Why are exports additive to GDP while imports are deductive? If the goal of GDP is to measure the goods and services provided to people within a geographic region, imports — not exports — are the benefit. Exports are but payment for imports. The problem and confusion arises because the GDP calculation unrealistically excludes other forms of payment: it should make a difference if imports are funded with increasing debt levels or if funds are accumulated from previous years of compensated exports. If China converted over $1 trillion in US debt instruments into imports of American goods and services, its people benefit today, but under GDP accounting, the negative impact of imports would offset greater consumption and/or government spending (the increase in GDP was previously realized in the years during which exports created a trade surplus).

GDP is Designed to Advance the Keynesian Agenda

Simon Kuznets (1901–1985) revolutionized econometrics and standardized measurements of GDP, with his research culminating in his 1941 book, National Income and Its Composition, 1919–1938. While not a Keynesian per se, the nature and timing of his research fueled the Keynesian revolution since central planning requires economic statistics. As Murray Rothbard noted:

Statistics are the eyes and ears of the bureaucrat, the politician, the socialistic reformer. Only by statistics can they know, or at least have any idea about, what is going on in the economy. Only by statistics can they find out ... who “needs” what throughout the economy, and how much federal money should be channeled in what directions.

GDP’s faulty theoretical underpinnings and politically motivated acceptance distort the performance and nature of an economy while failing to satisfactorily estimate a society’s standard of living. In fact, Kuznets partially understood this. In his very first report to the US Congress in 1934, Kuznets said “the welfare of a nation [can] scarcely be inferred from a measure of national income.” Yet the blind usage of GDP persists. That its permanence and persistence only serves the Keynesian policies of greater consumer spending, increased government expenditures, and larger exports through currency debasement should not be considered coincidental. Unfortunately, the resulting economic stagnation, debt accumulation, and price inflation are as inevitable as they are predictable.

I wrote about the GDP here.

Regardless of statistical mirages, eventually economic reality prevails. This means that for the Philippines, the obverse side of every politically induced credit inflated BOOM is a BUST.

On the headlong belief on the accuracy of the GDP, this quote largely attributed to Plato seems very relevant

The worst of all deceptions is self-deception 

Infographics: Austrian Economics versus Keynesian Economics

Courtesy of theAustrianInsider.com (HT Mises Blog)

For a crispier or clearer image pls go to the original site here