The case against price controls is not merely an academic exercise, restricted to economics textbooks. There is a four-thousand-year historical record of economic catastrophe after catastrophe caused by price controls. This record is partly documented in an excellent book entitled Forty Centuries of Wage and Price Controls by Robert Schuettinger and Eamon Butler, first published in 1979—Thomas DiLorenzo
In this issue:
Stagflation, Ahoy: January CPI Accelerates, Price Controls and QE to Fuel Higher Inflation, Treasury Markets Agree
I. BSP: What Stagflation?
II. January 2021 CPI Accelerates, Reinforces 2015 Uptrend
III. Price Controls Aggravates Disruption of the Division of labor and Say’s Law
IV. Inflation Diffuses into Non-Food Segments
V. The BSP’s Inflation Tax or Financial Repression
VI. The BSP’s Asset Bubbles
VII. Treasury Yields Steepen, Traders Expect Higher Inflation
VIII. Conclusion: Stagflation Ahoy!
Stagflation, Ahoy: January CPI Accelerates, Price Controls and QE to Fuel Higher Inflation, Treasury Markets Agree
I. BSP: What Stagflation?
So the dreaded word ‘stagflation’ has surfaced in media.
From the Philstar (February 5): Is the Philippines currently experiencing a bad combo of economic meltdown, massive joblessness and spiking inflation at the same time? The Bangko Sentral ng Pilipinas (BSP) does not think so. Fears that the economy is suffering from a phenomenon called “stagflation” surfaced on Friday after state statisticians reported that price increases soared past expectations in January. But for the central bank, which since November had maintained that bouts of inflation would be temporary, the anxieties are misplaced.
As discussed last December, five factors have amplified the risks of stagflation. These are:
1 Momentum and Trend
2 The massive disruption of the division of labor and Say’s Law.
3 The BSP has been implementing an inflation tax.
4 The BSP’s policy of inflating asset bubbles only underscores the aggravation of the misdirection of scarce resources.
5 Philippine Treasury markets have been saying inflation ahead!
This outlook will provide an update on the above.
Five Reasons Why Stagflation Risks Will Dominate the Philippine Economic Landscape in 2021 December 7, 2020
Nota bene: This author does not believe in the accuracy of the CPI simply because averaging different goods as potatoes, cars, laptops, and Netflix subscription fees represent a ridiculous and impractical exercise, and thus, do not reflect a realistic demonstration of price changes experienced by individuals writ large (community). Furthermore, since the CPI is a political-economic sensitive number, as per the PSA, "it is a major statistical series used for economic analysis and as a monitoring indicator of government economic policy", hence to advance the political-economic agenda of the incumbent such statistics are vulnerable to interventions. But anyway, using the lens of the mainstream, we extrapolate this data alongside the others to arrive at some clues of the political economy heading forward.
II. January 2021 CPI Accelerates, Reinforces 2015 Uptrend
1. Momentum and Trend
Figure 1
From GMA News (February 5): Inflation or the rate of increase in the prices of goods and services in January, at a 23-month high, exceeded the central bank’s expectations. For Bangko Sentral ng Pilipinas (BSP) Governor Benjamin Diokno, however, such a development is only “transitory. Inflation clocked in at 4.2% last month, its fourth straight month of acceleration and its fastest level in two years, amid faster increase in the prices of food commodities. The main culprit is pork, which saw an inflation rate of 17.1%.
For starters, ‘Transitory’ and ‘temporary’ looks like a BSP meme. They said the same thing during the publication of the CPI data last November and December.
Next, the 60-day price ceiling on pork and chicken products, which takes effect on February 8th, is designed to embellish statistical inflation than to augment supply.
That said, in the following months, the CPI may retain its current levels or could most likely decline. But that would be conditional to the surfacing of its aftereffects. If its ramification overwhelms the intended effects price ceiling, then the CPI may continue to advance.
After all, 2020 was a year of price controls.
The National Government froze food and medicine prices at the onset of the Enhanced Community Quarantine (ECQ) in March 2020. In the aftermath of the devastating effects of consecutive typhoons, authorities declared a 60-day price freeze covering Luzon.
And to the extent of public alarm over raging food prices, only Zamboanga declared a state of calamity during the rice crisis in 2018. On the other hand, a week ago, runaway food prices impelled authorities to declare a national state of calamity.
Last week, the House of Representatives has launched an inquiry on high food prices.
If today’s food crisis is worse than 2018, why is the CPI lower?
The likely answer is in the Philippine Statistical Authority’s statistical construct of the CPI pie. Bread and cereals CPI (includes rice and corn) command a larger 13.45% share twice that of the meat CPI at 6.25%.
For authorities, it is all about numbers presented as objective data. Whether this is relevant or accurate, no one bothers to ask.
Nevertheless, this background provides us a clearer picture of the CPI.
As explained back in December,
The 5-year and 1-year uptrends have barely been in accord with the claim that November’s CPI represents a “transitory” phenomenon.
The CPI of January 2021 has done two things. The upside momentum of the headline CPI’s 1-year price trend accelerated further, reinforcing the 2015 long-term trend. Meanwhile, the core CPI also broke past its resistance level marked by the January 2020 high to signal its broadening.
Yes, the CPI number may be lower, but unlike in 2018, the National Government’s response has been more drastic.
In the context presented above, while there may be an interregnum in the CPI’s advance, momentum and trend indicate more upside over time.
III. Price Controls Aggravates Disruption of the Division of labor and Say’s Law
2. Price Controls Exacerbates Disruption of the Division of labor and Say’s Law.
Again, from last December,
The National Government’s quarantine policy has caused a monumental structural disruption of the division of labor, which not only has curtailed and deformed the entwined, interconnected lattice networks of supply and demand chains but likewise, through price caps, has been reinforcing maladjustments.
I’m not the only one now preaching the destructive consequences of price controls.
From UP economic professor Ramon Clarete, (bold mine)
By fixing the price at below its market level, the government in effect taxes producers, causing supply to contract further and feeding more fuel to the price spike. The problem calls for assisting producers to produce more in order to restore normal levels of supply, and relieve pork buyers of high prices. Telling hog producers to sell scarce pork at below market value kicks them out of the pork business instead, and blows away our prospects of quickly normalizing production.
Price capping will not even help pork consumers, particularly the poorer ones, that it is intended to assist. Price freezes, particularly on essential food items, tend to be difficult to enforce. The measure will just create a parallel or black market for pork, the price of which exceeds their official level.
Ramon L. Clarete, Another way of solving the pork price crisis BusinessWorld January 31, 2021
Elucidating the ineffectiveness of price controls is not about ideology but economics 101.
His conclusion
The more the government invests in enforcing the official price, the more the price cap looks like a wrecking ball destroying our pork production and marketing capability, evaporating the pork supply further in the process. In the end we all get a triple whammy with a price control on pork: pork producers will quit the business, pork buyers will be hungry and angry, and the authorities will waste public resources in enforcing an order that is difficult to enforce.
Amen to that!
Unfortunately, the author stops there.
Because price controls are doomed, expect a broader expansion of government interventions. Or, price controls tend to beget price controls, which ultimately may lead to (old-school) socialism.
From the great Austrian economist Ludwig von Mises,
Thus the government is forced to go further and further, fixing step by step the prices of all consumers’ goods and of all factors of production — both human, i.e., labor, and material — and to order every entrepreneur and every worker to continue work at these prices and wages. No branch of industry can be omitted from this all-round fixing of prices and wages and from this obligation to produce those quantities which the government wants to see produced. If some branches were to be left free out of regard for the fact that they produce only goods qualified as non-vital or even as luxuries, capital and labor would tend to flow into them and the result would be a drop in the supply of those goods, the prices of which the government has fixed precisely because it considers them as indispensable for the satisfaction of the needs of the masses.
But when this state of all-round control of business is attained, there can no longer be any question of a market economy. No longer do the citizens by their buying and abstention from buying determine what should be produced and how. The power to decide these matters has developed upon the government. This is no longer capitalism; it is all-round planning by the government — it is socialism.
Ludwig von Mises, The Middle of the Road Leads to Socialism p.8 Mises.org
How relevant is this today?
From GMA News (February 3): The Department of Agriculture (DA) is studying the imposition of a price ceiling on pork and chicken for farmgate and traders, its spokesperson, Assistant Secretary Noel Reyes, said on Wednesday.
How about farm inputs, as well as inputs of the former; will these be next?
Will other food items, like beef, fish, and vegetables follow?
The UP professor said that the “price cap looks like a wrecking ball destroying our pork production and marketing capability, evaporating the pork supply further in the process.”
Below are news anecdotes validating this economic theory…
From the Inquirer (January 26): Hog and chicken raisers, supermarkets, as well as economists who talked to the Inquirer thumbed down the idea, noting that price control would not solve the root of the problem—lack of supply. “Some of our members are saying that they would postpone slaughtering their hogs once the directive is passed. It would only discourage hog raisers from reinvesting,” said Edwin Cheng, president of the Pork Producers Federation of the Philippines Inc.
From the CNN News (February 1) Even poultry raisers are crying foul over the price ceiling. The United Broilers and Raisers Association said farm inputs and even the price of chicks are at an all-time high. “Kung hindi kami kikita dahil sa price freeze, walang mag-aalaga sa mahal ng inputs. All-time high ang presyo ng sisiw, ngayon lang naging P50 ang sisiw,” said UBRA chairperson Gregorio San Diego. [Translation: If we cannot earn because of the price freeze, no one will raise poultry because of the high inputs. The price of chicks is at an all-time high at P50.]
From ABS-CBN News (February 5): This is also the view of Pork Producers Federation of the Philippines Inc. Vice President Nicanor Briones. He fears that Metro Manila will lose supply due to the price cap. "That will definitely happen. That 's why I'm afraid that Metro Manila will lose pigs. Eh, even I, Metro Manila traders can't buy, where can I give it? I will give it to those who can get our pigs," he said. Briones. Some sellers in the Commonwealth Market, however, decided to stop selling pork first when the price ceiling is implemented. According to Commonwealth Market administrator Bon Aga, of the 50 pig seats, only two are expected to open on Monday. Many chicken spots also choose not to open.
From GMA News (February 3): Some pork retailers and traders on Wednesday said they might go on a “pork holiday” once the price ceiling for pork and chicken is imposed in Metro Manila. According to Maki Pulido’s “24 Oras” report, some retailers will not sell pork during the 60-day implementation of the price cap to avoid losses and penalties for violation.
For pork, the National Government proposes more special hog lanes to facilitate transit for commercial flows, increase loan facility amounting to Php 1 billion for its repopulation, and more importantly, reduce tariffs to triple pork supply imports.
It also lifted the ban on 'galunggong' fishing.
As World Bank President David Malpass recently wrote, "To avoid artificial shortages and price spikes, food and other essential goods must flow as freely as possible across borders."
Echoing the rice crisis, because the Philippine agriculture industry remains heavily protected from external trade, recurrent supply shocks render the economy vulnerable to periodic food crises.
Moreover, the absence of a futures market, as I have been saying elsewhere, remains an obstacle to the productivity growth of the industry.
Though imports may help, surging global food prices, which reached 2014-high last January, erode this advantage. Nevertheless, competition is the key to attain efficiencies. (Figure 1, middle window)
IV. Inflation Diffuses into Non-Food Segments
2. A. Supply Disruptions Surface in Manufacturing
To be sure, while the economic shutdown and the previous price controls affected the food supply network, the dislocations from Asian Swine Flu and typhoons magnified it.
Likewise, while food inflation has grabbed the public’s attention, the supply bottlenecks have been widespread in the economy. For that reason, just a spark in demand growth should bring to the surface such imbalance, fueling an acceleration of inflation.
Proof? The broadcasted economic green shoots may instead be about the percolation of inflation.
From Markit (February 1) on the 25-year high manufacturing survey.
On the price front, material shortages led to greater charges at suppliers with input prices rising at the sharpest rate in over two years. As a result, output charges rose with firms passing on part of the hike in cost burden to clients….
"That said, signs of fragility remained evident with staffing cuts and sharp cost pressures mounting. At the same time, virus-related restrictions contributed to substantially longer delivery times and subdued foreign demand.
That is, to beat the pressures from surging input costs, manufacturers have been in a rush to produce, hoping to protect margins by shifting the burden of such price increases to clients. Mounting input costs, falling margins, and eventual decline in volume sales and cost-cutting are barely signs of green shoots.
The PSA’s Producers Price Index jumped .72% month-on-month last December, decreasing its price contraction to 2.38% year-on-year. The PPI of January may have turned positive. (Figure 1, lowest pane)
Again, just watch how street inflation conflagrates on a slight pickup in demand!
V. The BSP’s Inflation Tax or Financial Repression
3. The BSP has been implementing an inflation tax.
Figure 2
With the continuing weakness in aggregate demand, as evidenced by the tumbling of banking loans to multi-year lows last December, sure, the most convenient culprit would be the supply side. (Figure 2, upmost pane)
But indeed, supply shocks tend to be transitory if markets are allowed to function and if money supply growth has been static.
However, that’s not the case in the current setting.
The fact is that money supply growth surged from the 3Q of 2019 then peaked in May 2020, two months after the BSP’s QE announcement, which means some sectors benefited from the political dole out.
In this case, demand remained robust for the National Government and the financial industry even as demand in the general economy continues to flounder. These were the only sectors (aside from information and technology) that posted positive GDP growth in 2020. (Figure 2 middle pane)
Although Government GDP continues to surpass the private sector since 2008, this outperformance intensified from 2017 onwards.
Besides, money supply growth tends to peak ahead of the CPI.
Money supply growth climaxed in 2017, while CPI reached its zenith in 2018. With money supply culminating in May 2020, the CPI may hit its acme by the 2Q to the 3Q, but this is subject to the BSP’s reactions. (Figure 2, lowest window)
Since increases in money supply are the genuine causes of sustained rising prices, wherein the injections of new money foster and nurtures imbalances between forces of demand relative to supply, the lagging effect of the CPI is natural.
That said, food prices are sensitive politically. A sustained surge in food prices could undermine the popularity ratings of the administration. With the national elections on the horizon, such erosion of political capital could weaken its ambitions.
Perhaps, designed to shore up its political standing, the administration imposed the 60-day price cap to reinforce its "do-something" image.
In the realm of politics, someone’s mistake is the government’s credit.
Forget that the present gridlock in supply has partly been a product of the previous controls.
Figure 3
The BSP, in reality, has been pursuing to reflate the economy through negative real rates.
The financial repression approach of pushing interest rates below inflation, or negative real rates, effectively subsidizes soaring public debt levels (54% of GDP as of 2020). The CPI-BSP ON RRP spread has reached an incredible 2%. (Figure 3, upmost window)
It also keeps at bay pressures on a system laden with excess leveraging, as well as provide subsidy to the banking system by expanding interest margins through the steepening of the Treasury yield curve. Total universal and commercial bank loans plus public debt hit a staggering 104% of 2020 GDP, a record!
The consensus mistakes public debt as an isolated factor. No. Public and private sector debts are enmeshed. In a paper money system, the money supply must continue to grow, supported by debt from the private sector or the public sector, or both; otherwise, the fractional reserve banks will collapse. (Shostak, 2021)
So while defending the financial system from deflation, the consequences of the BSP’s inflationary policy percolates in the Main Street. The inflation genie has escaped its bottle!
After all, the BSP monetary anchor is all about inflation targeting, designed for a “low and stable inflation, supportive of the economy’s growth objective”.
VI. The BSP’s Asset Bubbles
4. The BSP’s policy of inflating asset bubbles!
Figure 4
Under the euphemism of raising confidence or the animal spirits against risk aversion, the BSP has encouraged the use of excess liquidity it infused into the financial system to chase asset prices, and subsequently, hope for the revival of credit expansion. (BSP FSR 2H 2020)
The actual goal of asset inflation is to combat deflationary pressures on the banking system. It seeks to prevent collateral values held by institutional creditors, mainly banks, from collapsing.
The financial system weathered the 2020 recession mainly from the BSP's bailout, as pointed out above. Asset inflation played a significant role in its politically induced expansion.
The BSP also hopes that the few who benefit from asset inflation will go on a spending binge, which would create a multiplier through the wealth effect.
And naturally, as people see the purchasing power of their currency shrink, the enticement to gamble away their savings to wangle marginal gains in the face of reduced economic opportunities have become strong. Why invest in the economy in an environment filled with uncertainties when a few fluctuations can provide juicy returns?
So the fun part is that the rising CPI has coincided with a higher PSEi 30. (Figure 4, upmost pane)
The great journalist Henry Hazlitt explains it best
Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody’s cost of living, imposes what is in effect a tax on the poorest at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system and corrupts public and private morals.
Henry Hazlitt, The Cure for Inflation, What You should Know about Inflation, p.18 Mises.org
The sad part is that malinvestments from speculative excess results in a prospective bust that diffuses into the economy.
The unwinding of bubbles will contribute to the general tightening of money that should add to the pressure of increasing rates.
To prevent this, the BSP will need to expand its balance sheet perpetually, with no blueprint for an exit.
For now, until the CPI reaches a threshold of political pain, its correlation with the PSE may persist. Are we near the tipping point?
VII. Treasury Yields Steepen, Traders Expect Higher Inflation
5. Philippine Treasury markets have been saying inflation ahead!
Treasury yield spreads, which incorporate market perception of inflation, interest rate, economic conditions, and more importantly, monetary policy, have accurately forecasted the CPI trends. Since 2008, the monetary policy has become more relevant.
The current trajectory of 10-year spreads (with 3 and 6 months) points to a higher CPI, with likely bumps ahead. The other 10-spreads are likewise widening. (Figure 4, middle and lowest window)
Remember that the Philippine treasury market has been dominated by local financial institutions both public and private. While their highly paid analysts or economists predict 'slowflation', their Treasury traders have been doing the opposite—pushing for wider spreads.
Although the BSP desires some inflation, it has no control over the policies it implements in the open arena. It lacks the decentralized subjective knowledge required for economic calculation. And when combined with the administration’s embrace of socialism, the outcome has been toxic. And the Treasury markets will show us the way.
VIII. Conclusion: Stagflation Ahoy!
At the start of this outlook, the BSP expressed denial of the risk of stagflation.
Figure 5
But what is stagflation?
Stagflation is an environment characterized by reduced income, revenue, and output leading to job and wage losses in the face of surging street prices.
Again, the BSP denies this, but stagflation is already here.
Yet how can demand recover when authorities continue to put significant barriers on supply while attempting to defeat economics 101 with edict? Wouldn’t this result in more inflation?
At the end, stagflation is a product of the BSP’s policy of inflation targeting gone awry and the incumbent’s embrace of socialism.
