The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last—Ludwig von Mises
In this issue
July Headline CPI of 1.7% a 46-Month Low Marks The Bottoming Phase? Consumer Credit, BSP’s QE and Treasury Markets Say So
-July Headline CPI Plunged to 46-Month Low as Core CPI Remains Elevated
-The Backlash on Low Inflation: The NG Walks Back Rice Tariffication!
-The Return of Inflation: 49% Spike Consumer Loans, Cash in Circulation Jumped in July!
-The Return of Inflation: The BSP Recharges QE in June and July!
-The Return of Inflation: Domestic Treasury Market’s Bearish Steepening!
-Conclusion: Brace for Stagflation and a Significantly Lower Peso!
July Headline CPI of 1.7% a 46-Month Low Marks The Bottoming Phase? Consumer Credit, BSP’s QE and Treasury Markets Say So
July Headline CPI Plunged to 46-Month Low as Core CPI Remains Elevated
The National Government’s statistical measure of the consumer’s purchasing power, the Consumer Price Index (CPI), plummeted to 1.7% in August, a 46-month low, from 2.4% a month ago, reported the Bangko Sentral ng Pilipinas. After peaking at 6.7% in September 2018, the CPI has been down in 10 out of the last 11-months. As of August 2019, the headline CPI cratered by 501 bps or by 74.77% from its peak.
Figure 1
The August CPI’s decline was primarily attributable to the crash in Food and Non-alcoholic beverages CPI to .56% in August from 1.91% a month ago, a 70.7% collapse! The Food and Non-alcoholic beverages CPI accounts for the biggest share of the CPI statistical basket at 38.34%.
However, core CPI, which excludes food and energy prices, posted a modest decline to 2.93% from 3.2% a month ago. Core CPI climaxed at 5.1% in November 2018, and have declined by 217 bps or by 42.55%.
In contrast to the headline CPI, core CPI remains at levels equal to the highs the previous CPI spike in 2013-14. And unlike in the previous inflation episode or in 2014-2015, where both headline and core CPI pulled back at almost the same pace, the present “stickiness” in the core CPI has prompted for divergent rates.
Put differently, while the headline CPI gets the public’s attention, the non-food and non-energy CPI, which has decreased at much lesser rates, seem to be telling a different story.
The Backlash on Low Inflation: The NG Walks Back Rice Tariffication!
The NG’s response to the 2018 rice crisis, on the supply side, was to implement partial liberalization of rice imports by converting import quota or quantitative restrictions (QR) into tariffs. The rice tariffication bill was enacted into an edict by the political leadership in February of this year.
However, with a barrage of imports, the so-called “market failure” has been attributed to declining farm gate prices that has adversely been affecting the income of farmers. It is as if the rice market has operated under a laissez-faire environment, that is without tariffs and other regulatory barriers.
Tariffs skew the economic benefit toward wealthy traders and the politically connected insiders at the expense of the consumers and small to medium scale entrepreneurs.
In short, the NG will implement measures that would implicitly walk back the tariffs based rice imports. Politics, rather than the markets, will determine prices and allocation of rice. Market failure, eh?
The converse of “The more you tax of something, the less you get of it” is that “When you subsidize something, you get more of it”. The administration’s farmer subsidies should mean more of it, or farmers would produce more “palay” regardless of consumers demand.
Such subsidies would effectively crowd-out other farm produce that leads to less agricultural production elsewhere. And such should lead to increased deficit spending that would crowd-out not only the private sector but likewise other forms of public spending, as well. Think ‘build, build, and build’.
And though I’m no fan of the CPI, which represents meaningless statistical numbers to justify manifold interventionism, the disparate rate between the core inflation and the headline inflation may signify an incipient manifestation of the crowding out syndrome. That is to say, the reemergence of price inflation may take hold in other commodities or goods rather than on rice.
Populist politics have anchored their belief on free lunches: expectations of the preservation of the income of inefficient farmers in the paradox that rice prices should continually fall! Or, are they really after higher inflation rates?
Be careful of what you wish for.
The Return of Inflation: 49% Spike Consumer Loans, Cash in Circulation Jumped in July!
And the CPI has shown signs of bottoming.
Figure 2
The plunge in the CPI, have partly been though supply adjustments, through the rice tariffication mandate.
But unknown to most, demand played the most substantial part in the CPI. Slowing money supply growth, otherwise known as domestic liquidity, has sloughed off demand in many parts of the real economy.
The most popular measure of money supply growth, the M3, has been downhill since its apogee in August 2017 at 15.77%. And such monetary tightening partly emanated from 6-rate increases implemented by the BSP for an aggregate of 175 bps from May to November 2018. That is, ever since culminating in August 2017, the lagged effects of the monetary tightening expressed through the CPI appeared 13-months later.
With the banking system issuing a significantly reduced rate of growth in loans, the rate of circulation of money followed suit. However, the steep decline of the money supply growth may have found a bottom during the last three months, where growth seems to have steadied.
Let us hear it from the BSP’s July report: “Preliminary data show that domestic liquidity (M3) grew by 6.7 percent year-on-year to about ₱11.9 trillion in July 2019, slightly faster than the 6.4-percent growth in June. On a month-on-month seasonally-adjusted basis, M3 increased by 0.8 percent. Demand for credit eased slightly but remained the principal driver of money supply growth.” (bold added)
And which part of the economy has been borrowing? The BSP provides the answer: “Loans for production activities—which comprised 87.6 percent of banks’ aggregate loan portfolio, net of RRPs—grew by 9.8 percent in July, similar to the pace recorded in the previous month. The growth in production loans was driven primarily by lending to the following sectors: real estate activities (18.1 percent); financial and insurance activities (19.1 percent); electricity, gas, steam and air conditioning supply (13.8 percent), construction (38.2 percent); and wholesale and retail trade, repair of motor vehicles and motorcycle (4.5 percent)…Meanwhile, loans for household consumption grew by 23.0 percent in July from 15.3 percent in June, due to faster growth in motor vehicle and salary-based general purpose consumption loans during the month.” (bold added)
So while production loans growth remained at 9.8% for the second month, a growth rate was last seen in 2010, consumers, for unknown reasons, suddenly went on a borrowing binge!
Household credit surged across the board: credit card debt grew 25.62% in July slightly lower than 26% a month ago. Auto loans growth rate more than doubled to 24.99% from 8.9%, and payroll loans soared more than 5x to 6.37% from .96% in June.
In aggregate, household loans spiraled to 23% in August from 15.4% a month ago for a 760 bps increase or a 49% surge in growth rates! As a result, cash in circulation, as measured by likewise soared to 6.85% from 5.5%, over the same period, accounting for a whopping 24.5% increase.
That is to say, the spike in bank lending to the households resulted in a jump in circulating cash!
And with the asymmetric rates between household and production lending revealing a jump in demand relative to stagnant supply, this points to HIGHER CPI ahead!
The Return of Inflation: The BSP Recharges QE in June and July!
Figure 3
And there’s more.
The NG-BSP launched its version of quantitative easing or direct funding of the national government through purchases of domestic treasuries in 2015 when the CPI hit negative in September (-.4%) and October (-.2%). Though the BSP had backed off from using this emergency tool during the start of the year, it has begun to reactivate this toolkit over the last two months.
From the BSP: “net claims on the central government contracted by 1.8 percent in July following a 3.9-percent decline in June as a result of the increase in deposits by the National Government with the BSP.”
On a month-on-month basis, Php 74.5 billion was added to the Net Claims on central government in July, which was the second month of additions from Php 50.9 billion in June. Year to date, the deficit in the net claims on the central government have been reduced to Php 90.73 billion or 1.8% lower year on year.
Figure 4
So while the NG has slowed in raising debt from the capital markets, the BSP has been gradually taking over.
For a broader view: Total public debt growth dropped to 10.8% in July, from 12.15% in June and 15.85% in May. In the meantime, the aggregate bank credit growth (production plus household, excluding RRPs) was 10.9% in July, higher than 10.3% in June but lower than 11.75% in May. In total, public and bank credit growth slowed to 10.86% in July from 11.19% in June and 15.85% in May. Nominal or current price GDP was 6.6% and 7.4% in the first and second quarter, which means systemic leverage has grown almost double the rate of the indicated statistical economic growth! And as of July, total system leverage ballooned to an unprecedented Php 16.1 trillion which redounds to a stunning 91% of the annualized 2019 NGDP! All these have only beneficial effects in the eyes of the mainstream!
To this end, alongside the spike in bank loans to household credit, the reactivation of the BSP’s QE has helped enhanced the cash segment growth of the money supply.
More importantly, if the BSP’s statistics on bank lending and domestic liquidity is accurate, then all these points to a coming reversal in the CPI. Or July’s CPI could mark the bottoming phase of the inflation cycle.
The Return of Inflation: Domestic Treasury Market’s Bearish Steepening!
And it doesn’t stop here.
Figure 5
From a yield curve collapse which ended with an inversion in the 2Q 2019, domestic treasuries have begun to show signs of steepening with the longer-maturities rising faster than the T-Bills, a “bearish steepener”. Though the present steepening may be from expectations of more monetary loosening from the BSP, the widening curve may also signal the return of inflation.
As the investopedia describes the bearish steepener, “If traders and investor start to worry about inflation and greater government borrowing, it is likely longer-term interest rates will rise more than interest rates on short-dated bonds.”
Should the BSP fulfill the expectations of the treasury markets, the widening dynamic of the treasury curve is likely to persist. At present, the spread of the PDS 10-year bond and 1-year note have risen but has yet to reach its previous low levels of 1 to 1.5.
External events have likewise been influencing local treasury market. Expectations for the US Federal Reserve to cut rates have prompted the 10-year UST to resonate with the domestic counterpart.
But CPI numbers are likely to become divergent soon.
Instead of a recharged inflationary boom, the Philippines may likely experience stagflation!
Conclusion: Brace for Stagflation and a Significantly Lower Peso!
-July headline CPI dropped to a 46-month low even as Core CPI remains at 2014 highs. Asymmetric CPI rates point to a divergence in inflation dynamics ahead.
-Lower CPI has boomeranged in the context of populist politics. Lower rice prices have spurred the populist demand for the preservation of farmer’s income through NG subsidies. Or, Populist politics appear to be pining for the return of inflation, as the NG walks back on tariff-based rice imports.
-Even as production loans remain stagnant in July, household credit spiked by almost 50%. The substantial jump in bank lending to the households, have contributed immensely to the spike in cash growth rates. With credit lending down on the production sector, the spike in household lending points to higher inflation rates.
-So the NG has been penny-pinching on public spending while ramping up its cash hoard with record amounts of debt financing from the capital markets. In the last two months, as public debt slowed, the BSP has silently been re-instituting the use of Quantitative Easing, which should have inflationary outcomes overtime.
-Philippine treasury markets continue with the bearish steepener dynamic, or faster increase of yields of Bonds relative to Bills, a harbinger of inflation.
Instead of an inflationary boom, brace for stagflation and a significantly lower peso.
