Inflation is the true opium of the people and it is administered to them by anticapitalist governments and parties.—Ludwig von Mises
In this issue
The Two Rules of the Inflation Club, BSP’s QE Hits Fresh Record in July, Government’s FSCC “Shocked” by “Dislocations of Crisis Proportions”
-The First Rule of the Inflation Club: Do Not Talk About the BSP’s Role
-STREET Inflation Versus Statistical Inflation!
-Record 7-Month Fiscal Deficit Financed by Record BSP QE and Rapidly Growing Public Debt
-The Inequality of Financial Liquidity; CPI Driven By the BSP and NG’s Spending
-Sound Macroeconomic Conditions? National Government’s FSCC Admitted to Being ‘Surprised’ From “Dislocations of Crisis Proportions”
The Two Rules of the Inflation Club, BSP’s QE Hits Fresh Record in July, Government’s FSCC “Shocked” by “Dislocations of Crisis Proportions”
The first rule of Fight Club is: You do not talk about Fight Club. The second rule of Fight Club is: You do not talk about Fight Club.—Tyler Durden, The Fight Club (1999)
Fight club movie clip here:
The First Rule of the Inflation Club: Do Not Talk About the BSP’s Role
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
Lo and Behold!
Figure 1
The Bangko Sentral ng Pilipinas (BSP) on July domestic liquidity conditions: “Net claims on the central government also rose at a slower pace of 12.3 percent in July from 12.8 percent (revised) in June, even as borrowings by the National Government continued to increase.” (bold mine)
The BSP increased its inflation forecast for August: “The BSP Department of Economic Research projects inflation in August 2018to settle at around 5.9 percent, with a range of 5.5 – 6.2 percent. The central forecast implies a slight deceleration of the month-on-month inflation. Higher price of rice and key food items due to weather disturbances and supply disruptions, increase in gasoline and LPG prices, and slight upward adjustment in electricity rates in Meralco-serviced areas contributed to upward price pressures in August. Meanwhile, lower diesel and kerosene prices as well as modestly appreciated peso could partly temper price pressures this month. The BSP will remain watchful of economic and financial developments that could affect the inflation outlook and will closely monitor inflation expectations and emergence of further second-round effects ahead of the September 2018 Monetary Board policy meeting.”
Experts weighed in to make their forecasts.
The ING sees a breach of the 6% level which it describes a “monster inflation”. Most analysts, polled by the CNN Philippines andothers, see statistical inflation to hit a 9-year high in August.
There is NOT a single mention of how the BSP’s emergency tool has ignited STREET inflation!
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
STREET Inflation Versus Statistical Inflation!
Of course, statistical inflation is DIFFERENT from STREET inflation.
Authorities and experts FRAME inflation to the gullible public as merely a statistical artifact.
Yet, there has been a deluge of media articles covering the rampaging inflation in the form of a food crisis.
I showed 17 of them in two days (August 28 and 29). (Runaway Inflation? Mainstream Media Articles Covering Inflation and Food Crisis Soar! August 29)
The list has only grown.
August 30, 2018
August 31
September 1
September 2
18 articles in the last four days!
Do all these seem like an inflation rate at single digits?
Panic has seemingly gripped the politicians and bureaucrats!
To generate popular appeal for future votes, politicians intuitively use virtue signaling. That is, they grandstand by pandering to events that affect a considerable segment of their constituency base to ensure their popularity.
So when they show signs of panic, because of the rice crisis and “galunggung” shortages, such should imply that a vast number of the populace are getting smacked hard by raging STREET prices.
And to exhibit the urgency of the situation, antidotes, mostly kneejerk, had been proposed by them, ranging from abolishing the NFA, the resignation of its leaders, legalizing smuggled rice, lower tariffs on imports, instituting price controls, building infrastructure, and more.
In a statistical context, food items account for 35.46% of the CPI basket. Rice has a 9.59% share, while fish has a 5.74% share.
So a rice-galunggung-food crisis should entail inflation rates at much higher rates than official and mainstream estimates.
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
Record 7-Month Fiscal Deficit Financed by Record BSP QE and Rapidly Growing Public Debt
Demand does not exist in a vacuum.
For an economic activity to take place, demand has to be funded.
The record Php 279.4 billion 7-month deficit, representing 2.9% of GDP had been financed mainly by the BSP. Public borrowing came next.
Here are the numbers. While Net claims on the central government, according to the BSP, grew by 12.3% in July, the National Government’s domestic debt grew by 10.95% in July (figure 2, upper window)
In the 7-month period, domestic debt grew by Php 159.3 billion, to account for 57.01% of the share of the period’s fiscal deficit. Meanwhile, the BSP’s Php 219 billion QEs constituted the balance and the Php 98.9 billion excess had been possibly used to “manage” the treasury yields and its curve.
There is no free lunch.
Since the BSP engaged in QE in 2015, the correlation between the record ascent in Net claims on the Central Government with the CPI became tight. (see figure 1, upper window) Yes, the NG has been crowding out the banking system.
This tightening correlation demonstrates the effect of the BSP’s liquidity creation or money from thin air, to finance the NG’s expenditures, on prices of the real economy. By bidding up on goods and services, government actions affect prices and the consequent demand and supply schedules for specific items or services acquired.
The BSP’s QE accounts for about 17% share of the M3 money supply.
Net claims on central government which has ballooned by Php 32.8 billion in July to Php 1.854 trillion signifying 19.3% of the 7-month GDP. The BSP’s QE hasn’t only affected real economy prices by disproportionately pushing up demand, through the inflation of the quantity of the peso, such has depreciated the value of the currency. (figure 1 lower window)
Figure 2
Add to the pesos’ quandary the rapid decline in the BSP’s net foreign asset portfolio which growth rate has stagnated in July (+.01%). The BSP’s net foreign asset growth has plummeted to 2012 lows reportedly “reflecting the decrease in gross international reserves”. (figure 2 lower window)
So as the BSP continues to print money from thin air, domestic inventories of the US dollar have been dropping, worsening the imbalance in a monetary system anchored on the US dollar.
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
The Inequality of Financial Liquidity; CPI Driven By the BSP and NG’s Spending
And the distribution of domestic liquidity hasn’t been the same for economic agents.
Figure 3
As I pointed out last week, the banking system is in trouble. [It’s not just the banks, even the non-bank financials have emitted similar symptoms]
Despite a sustained robust increase in the growth of the banking system’s loan portfolio last July, tumbling growth of cash and due banks (June) has resonated with sharply dropping peso deposits and importantly, the substantial deceleration of domestic liquidity M3 (July).
So, the government enjoys abundant liquidity from the BSP’s subsidy, however, the trend of liquidity shortages have become magnified within the banking system
The government’s demand for resources and money has been crowding out the banking system. And the banking system’s growing woes have likewise manifested the unintended consequences of BSP’s unsustainable inflationary policy.
That’s not all. The government cannot rely on debt financing for its spending from the capital markets alone. Doing so would lead to a liquidity drought that sends interest rates rocketing. So the BSP has played a significant role in it. Not just for financing, but to intervene in the pricing system to guide prices towards the desired direction.
The political spectrum believes that interventions will deliver only benefits, ignoring the costs associated with it. Unfortunately as shown below, markets come back to ‘shock’ them.
Going back to the liquidity of the banking system, with an estimated 82% share, the Philippine financial system’s liquidity conditions depend on the banking system as its critical source.
Should liquidity conditions in the industry continue to deteriorate, to conserve resources banks will have to eventually become restrictive.
And I suspect the present banking conditions have been due to a substantial increase in unreported or closet Non-Performing Loans. If my suspicion is right, for a system dependent on credit expansion for growth, a credit expansion slowdown or stagnation or at worst contraction, would destabilize or shock the system.
And instead of build, build, build, the NG’s actions would then shift towards nationalization and or bailouts. Prodigality will then shift to austerity.
However, under such conditions, social stress drums up. Political tremors follow. History tells us that the last two People Power Revolts (1986 and 2001) occurred in the aftermath of an economic or financial dislocation (recession anddebt rescheduling 1983-1985 and the 1997 Asian Crisis)
Back to statistical inflation.
Declining liquidity implies reduced demand. CPI, NGDP, bank lending and earnings should decline under normal circumstances, but it hasn’t.
The implication for the last few months, the CPI has become less about bank funded domestic demand.
The CPI, thus, has been mostly about BSP’s funding of the NG’s deficit spending.
But of course, CPI may lag the changes in the banking system’s conditions. So if liquidity continues to fall, CPI may ease considerably. But such conditions also suggest credit conditions will tighten meaningfully.
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
Sound Macroeconomic Conditions? National Government’s FSCC Admitted to Being ‘Surprised’ From “Dislocations of Crisis Proportions”
And it has been interesting to see how the NG via the FSCC has raised on and confessed about concerns on financial stability because of debt!
The FSCC reportedly represents a voluntary interagency body composed of the BSP, the Department of Finance, the Insurance Commission, the Philippine Deposit Insurance Corporation and the Securities and Exchange Commission
From the Philstar, (bold mine)
Costlier debt servicing due to rising interest rates and exchange rate volatility is the biggest concern faced by the economy, and financial authorities are now planning to introduce “interventions” to manage risks arising from credit.
“What is clear is that interest rates are rising and emerging market currencies have been depreciating versus the United States dollar,” read the 2017 Financial Stability Report (FSR) released Tuesday by the inter-agency Financial Stability Coordination Council (FSCC).
“These must mean that debt servicing is now at a higher cost than in the past, separate from the issue of having more outstanding debt. This is our central financial stability issue,” the report added.
According to the FSCC, the change in market prices could trigger “negative outcomes” which, if not properly addressed, would amplify into “systemic consequences.”
“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,” the report read in part.
Figure 4
Sad to say, any analysis that fails to diagnose and address the principal source of imbalances, the solutions proposed and imposed should only worsen the problem.
And no, no, no, the falling peso and rising rates are symptoms of current and past policies.
Internal fragility brought about by the same policies has rendered the domestic currency vulnerable to the fluid and sharply oscillating conditions of the US dollar liquidity.
And yes while outstanding debt represents a financial stability issue, the paramount concern should be the direction of the use of such a massive pileup of debt or its allocation or Malinvestments. Debt used for unproductive activities will be exposed by rising rates and defaulted upon
As of July, total public debt grew by 10.31% while total bank loans expanded 19.5%. The combined public debt and bank loan portfolio grew by 14.86% over the same period.
Public debt stood at Php 7.044 trillion and bank credit at Php 7.48 trillion which totaled Php 14.521 trillion or 88.13% of the annualized GDP. (figure 4 lowest pane) And debt service (interest plus amortization) is set to zoom to about Php 794 billion (4.8% of GDP), a 2006 year high. (figure 4 middle window)
Even if interest rates remain at a record low, the pulsating growth of debt, which has grown faster than the economy, renders a system vulnerable from overleveraging
The system’s debt did not just pop up. These were products of actions in response to policies which shaped the economic environment. Today’s outstanding debt represents an aggregation of such a process.
And if “shocks that have caused dislocations of crisis proportions have come as a surprise”, why should we rely on their assessment of “no definitive evidence of a looming crisis”?
Differently put, they implicitly say that they should be trusted upon to protect us from a crisis, even if they didn’t see the shocks coming!
You see, these represent an admission that authorities have lost control!
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
