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!

The BUY EVERYTHING Party Poopers: Zhou Xiaochuan, Gordon Brown, Wolfgang Schaeuble, Jean-Claude Trichet, Klaas Knot and Richard Thaler

Signs of historic times, indeed…

 

From Rappler: (October 20, 2017)

A Dutch family has sold virtually all they own, including a business, their home, two cars and a motorbike and invested the takings in bitcoin just as the virtual currency is soaring to new heights.

"We are putting everything into bitcoin, we've sold everything to invest in this currency," Didi Taihuttu told AFP.

The 39-year-old is currently living in a camping ground with his family, aiming "to put as much money as possible to one side and transform it into bitcoin."

Having turned his back on a "materialistic life" three months ago, Taihuttu and his wife and three daughters, aged 12, 10 and seven, are living in a small holiday chalet in a camping ground in eastern Venlo in Netherlands and are watching their savings "grow every minute somewhere on the cloud".

Bitcoin smashed through $6,100 last Saturday, reported the CNBC, for a thundering over 500% return year-to-date.

Bitcoin has just been part of the overall risk ON moment. (upper window)

A deck of charts, I previously posted here, depicted that it has been a BUYING EVERYTHING! “It's Market Mania for Assets All Around the World”!

Well, risk ON everything and everywhere has only been intensifying.

Spread differentials of sovereign and high yield (corporate and emerging market) bonds have compressed to unseen levels. (middle chart) European junk bonds have even attained lower yields than the 10-year US treasury! Junk bonds have now achieved risk-free status! The world has turned upside down! And given the compressed spreads, even junk bond fund managers have turned or shifted into owning equities! (bottom chart)

While everybody seems to be enjoying the free money orgasmic shindig, notable party poopers have emerged.

The People’s Bank of China governor Zhou Xiaochuan warned of the “Minsky moment” (collapse of asset prices).

From John Authers of the Financial Times: October 21, 2017

What exactly is the Chinese for “Minsky moment”? The chances are that we will soon need to know, after a startling moment of clarity from the outgoing chairman of the People’s Bank of China.

Speaking on the sidelines of the Communist party congress in Beijing, Zhou Xiaochuan, who is soon to stand down as governor of the PBoC, said: “If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.”

This might sound unexceptional. But it is about as close as someone in Mr Zhou’s position can come to yelling “fire” in a crowded theatre. To quote Robert Hockett, an expert on China at Cornell Law School: “It’s calculated to inspire panic. It’s almost an incantation to panic — especially in China.”

Why rouse the Communist party congress to panic? Haven’t the Chinese government been successful in weeding out excess capacity in the property sector, such that ghost cities are now being filled or occupied?

 

It turns out that the Chinese government, through the local apparatchiks, has stealthily been bailing out developers and implicitly created a mass housing project.

From the Financial Tribune (October 15, 2017)

An attempt by the Chinese government to fill empty apartments is pushing indebted cities farther into debt. Over the past three years, more than 200 Chinese cities have been buying surplus apartments from developers and moving in families who live in neighboring villages or on condemned city blocks, a program it plans to continue through 2020, according to the Wall Street Journal. Local governments spent more than $100 billion in 2016 alone to either buy housing or subsidize purchases.

The central government is supporting this strategy through bank lending, and it has helped give the property market a boost, which makes up a third of China’s economic growth.

However, the strategy is undergirded by debt: cities borrow from state banks to pay for the subsidies and purchases, and they pay back the loans by selling more land to developers, who then build more housing and accumulate more debt, prompting another bailout from the state.

Local governments borrowed 972.5 billion yuan ($147.57 billion) last year from the government’s main housing lender, which was nine times higher than three years earlier. More than half of those loans went to housing purchases or subsidized buying, while the rest funded government-built houses.

First, the local government buys out inventories from developers. Then, they bus in people to have these occupied. Two birds in one stone!

So it is not economic growth but politics to camouflage excesses that have led to a cosmetic reduction of capacity. But as the article notes, there have been numerous ramifications.

One, both government and the private sector have only amassed more debt. Two, because developers were handed free money, they go and acquire new land for fresh inventory which led to sharply higher property prices. Three, which is tied to the second, property developers indulge in building more capacity. So excessesleads to even more excesses. These subsidies have only accumulated pricing and distributional distortions, which reveals the magnified extent of credit financed malinvestments.

China’s Total Social Financing has climbed by a whopping $2.9 trillion in 12 months EXCLUDING local government and other informal (shadow banking) debts! While bank debts have been exploding, China’s belly of the yield curve has inverted. Such inversion means that the bond market is expecting a sharp tightening of monetary conditions.

Wonder why Mr. Zhou sounded the alarm bells on the ‘Minsky Moment’? Could it be that the reason for Mr. Zhou’s retirement is because he intends to bail before the ‘Minsky Moment’ strikes?

Now to more party poopers… (all bold mine)

From ex-UK PM Gordon Brown (BBC September 28)

Former prime minister Gordon Brown has warned that the UK and other major economies are not well-equipped for the next financial crisis.

Mr Brown, who was in Number 10 during the banking crash of 2007-8, said they need to guard against "complacency" or "not being aware" of risks.

The next crisis could come from Asia's shadow banking sector, he suggested.

From former president of the ECB Jean-Claude Trichet (Nikkei Asia October 19)

Jean-Claude Trichet, former president of the European Central Bank, warned of ballooning global debt in a recent interview with the Nikkei, saying: "Be very careful. A new crisis can occur." The debt-to-GDP ratio, which has been rising primarily in emerging markets, is sending such signals, he said.

"I consider that an important indicator of economic and financial vulnerability, at the level of the global economy, would be the proportion between the overall outstanding global public and private debt as a proportion of the overall GDP," he said. The ratio increased as much as 25 percentage points between 2000 and 2007, from 250% to 275%. The jump was partly responsible for the global financial crisis. After the crisis, the figure is still rising, rather than falling, reaching 300% today.

From Germany’s Finance Minister Wolfgang Schaeuble (Business Insider October 9)

Germany's outgoing Finance Minister Wolfgang Schaeuble warned that spiralling levels of debt, as well as the growth of liquidity across the world, risk creating a new financial crisis…

"Economists all over the world are concerned about the increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt. I myself am concerned about this, too," Schaeuble said.

The claim that “economist all over the world are concerned about risks” seems like a fallacy of composition. That’s because this definitely does not apply to the Philippines.

From ECB’s Governing Council member and Dutch Central Bank president Klaas Knot (Bloomberg, October 9)

Financial markets may be underpricing global risks, leaving them vulnerable to a major correction, according to European Central Bank Governing Council member Klaas Knot warned.

As global stocks surge, measures of volatility suggest unprecedented calm even as crises around the world -- including the Catalan separatists in Spain, Turkey’s diplomatic row with the U.S., North Korea’s missile tests and the danger of a hard Brexit -- make political headlines.

“It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,” said Knot, who is also the president of the Dutch Central Bank.

Finally, recently awarded Nobel winner behavioral economist Richard Thaler (Bloomberg, October 10)

A buoyant and complacent stock market is worrying Richard H. Thaler, the University of Chicago professor who this week won the Nobel Prize in economics.

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.”

“I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked,” Thaler said, “Nothing seems to spook the market” and if the gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.”

The economist said that he didn’t know “where anyone would get confidence” that tax reform is going to happen.

Funny but, the Nobel awardee just forgot behavioral basics: the herd mentality and the post hoc rationalization for tax reform.

Forget them noisy party spoilers, JUST PARTY ON!