Illusion never ebbs slowly; it is always shattered. One either believes or one doesn't. The experience is inherently binary—Peter Atwater
In this issue
Stagflation Ahoy! NEDA Chief Says Recovery Will Take 10 Years! Will Surging Global Inflation Escalate Domestic Price Pressures?
I. BSP Policies and Fiscal Deficit Financing: As the Economy Suffers a Drought, Government Swimming in Liquidity!
II. NEDA Chief: Philippine Economy To Take 10 Years To Recover!
III. Scandinavian Nations Lifts ALL Covid-19 Curbs!
IV. Stagflation Ahoy! Supply Dislocations Meets Too Much Money Chasing Too Few Goods
V. Will The Recent Surge In Global Inflation Escalate Domestic Price Pressures?
Stagflation Ahoy! NEDA Chief Says Recovery Will Take 10 Years! Will Surging Global Inflation Escalate Domestic Price Pressures?
I. BSP Policies and Fiscal Deficit Financing: As the Economy Suffers a Drought, Government Swimming in Liquidity!
We have repeatedly discussed the prospect of stagflation.
Back in February…
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.
…
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.
…
Again, just watch how street inflation conflagrates on a slight pickup in demand!
And then again in March…
But again, the mainstream sees only statistics but neglects the interrelationship of money, demand and supply.
Undergirded by massive dislocations from the supply shock, even a slight pick-up in demand, most likely from fiscal policies is likely to combust street inflation at runway rates, thereby causing unintended consequences or defeating the BSP’s goals.
Be careful what you wish for.
To begin with, we discuss the crucial role played by the central government on current conditions.
Figure 1
From the CNN, September 23: The country's budget deficit reached ₱120.9 billion in August as government spending rose, the Bureau of the Treasury (BTr) reported Thursday. In a statement, the agency said the amount is thrice as high as the ₱40.1 billion recorded in the same month last year, but is lower than the ₱121.2 billion deficit registered in July. August's figure brings the government's cumulative fiscal deficit to ₱958.2 billion — a 29.36% jump. It's also equivalent to 52% of the revised ₱1.85 trillion program for this year. The BTr said public expenditure climbed by 34.2% to ₱380.2 billion during the month — the second highest growth recorded this year next to the 37.27% rate logged in February. The disbursement of several COVID-19 financing requirements such as cash aid to families affected by strict quarantine restrictions in Metro Manila, and subsidy releases to the Philippine Health Insurance Corp. (PhilHealth) led to higher spending in August, the bureau explained.
Inclusive of the growth rates of 3.87% and 9.2% in the first eight months of 2021, the nominal total revenues and BIR collections were off by only 4.1% and 4.4% from the record high of 2019. (Figure 1, upmost pane)
The other reason for the rapid closing of last year’s gap? Total revenues and BIR intake in 2020 suffered a shallow 7.7% and 10.3% pullback in the same period. Did the Philippines endure a historic (real) 9.6% (8.1% constant) recession in 2020? Fiscal data seem to suggest otherwise.
In the meantime, public expenditures surged by 10.94% to a record of Php 2.964 trillion in the last eight months. Because of this, despite the noteworthy collections, the National Government’s fiscal deficit soared to a record Php 958.2 billion. (Figure 1, second to the highest pane)
Be it known that public spending has been instrumental for GDP growth during this administration. It became especially pronounced in 2020 through the 1H of 2021.
A Bounce is Not a Recovery: 2Q GDP 11.8% Boom: Low-Base Effect and Government Spending Boom! August 15, 2021
Nevertheless, the National Government raised Php 2.12 trillion from the public, signifying a 6.4% dip from last year’s record Php 2.264 trillion. But this amount accounted for 221% of the deficit. (Figure 1, second to the lowest pane)
Figure 2
Along with the BSP’s direct and indirect QE (Figure 2 highest pane), the treasury’s eight-month cash hoard remained at a considerable Php 732.7 million, albeit 34.86% lower from the record Php 1.125 trillion a year ago.
Why has the public debt been in excess (121%) of deficit? Aside from debt rollovers, the BSP QE operations require Philippine treasury securities, thus, the massive issuance.
Proof?
From the BSP’s 1Q 2021 Philippine Balance Sheet Approach (BSA) Report, September 30: (bold mine)
At the same time, the GG (General Government) reversed its position with the Central Bank (CB) from a net creditor at P84.1 billion to a net debtor at P590.9 billion in Q1 2021. The reversal is due to GG’s liabilities to the CB which nearly tripled to P2.1 trillion from P740 billion a year ago. In particular, the CB more than quadrupled its government security (GS) holdings to P1.5 trillion from P329 billion due to its purchases of GS in the secondary market. Similarly, the GG’s liabilities to the ODCs (Other Deposit Corporations), which were mainly debt securities, also surged to P3.4 trillion from P2.9 trillion. Furthermore, the GG’s external indebtedness increased to P2.7 trillion from P2.2 trillion, on account of higher foreign loans of the National Government (NG).
Thanks to the zero-bound and QE policies of the BSP, while the National Government swam in cash, most of the economy suffered from diminished liquidity.
And since the government has no wealth on its own, its expenditures are funded by a combination of taxes, borrowings, and monetary inflation.
That said, outstanding public debt surged by 21.1% to a record Php 11.64 trillion in August. (Figure 1, lowest window)
But because the capital markets had been the significant source of this debt, the public sector crowded out savings and or resources from the private sector and households.
And it comes as no surprise that despite the QE, the growth rates of deposit liabilities in the banking system continue to dwindle. Since peaking in 2013, growth rates of total deposit liabilities have been in a downtrend. (Figure 2, second to the lowest window)
In response to the asset-buying program of the BSP, the growth of deposit liabilities rebounded from a multi-year low in October 2019 until the recent climax in June 2020 but since resumed its descent.
The same crowding-out effect applies to the BSP’s rescue of the banking system through Financial Repression.
It is deducible that through borrowing, monetary inflation, and Financial Repression, the public sector has played the PRIMARY role in the demand side of an economy forcibly shut.
And government expenditures, including so-called public investments, signify de facto consumption. But because such public expenditures are not subjected to the market tests of profit and losses, and thus, economic calculation but imposed on the public, the productivity of these projects is undetermined. In essence, unproductive investments are consumption. The great Austrian economist Ludwig von Mises was right, “A bureau is not a profit-seeking enterprise; it cannot make use of any economic calculation; it has to solve problems which are unknown to business management.”
Ludwig von Mises, Bureaucracy p.48 Mises.org
Government consumption will thus COMPETE with the private sector and households for scarce supply and services.
And because there are no free lunches, authorities are likely to resort to MASSIVE tax increases after the elections backed by current monetary policies designed to inflate this debt away.
In this scenario, exactly how will the economy and earnings recover when hobbled not only by restrained economic operations but also by surging debt servicing costs, higher taxes, and reduced purchasing power of the peso?
II. NEDA Chief: Philippine Economy To Take 10 Years To Recover!
Authorities know this. But they have been saying it discreetly.
Proof?
Remember this word of caution from the April 2020 Financial Stability Report of the BSP? (p.29)
The key element now is that NGs are taking on the burden for funding the needed relief program. There is no other entity in place that can absorb the ultimate risks and the corresponding financing. This will certainly mean higher debts, much less fiscal space. Intertemporally, this debt can be bridge-financed with more debt just to sustain liquidity. Ultimately though, taxes will have to adjust intergenerationally to make up for the gap. This is a policy issue that, for the moment, is pushed down the road but is unlikely to be avoided
And there’s more.
The chief of the National Economic and Development Authority (NEDA) stunningly predicted that the recovery from the pandemic-induced recession could take at least a decade!
From the Philstar, October 2: The Philippine economy will take more than a decade to return to pre-pandemic growth, an official said Thursday, warning the next two generations of Filipinos would be paying for the cost of COVID-19. Lockdowns and other restrictions aimed at slowing the spread of the coronavirus have shattered the Southeast Asian nation's economy, throwing millions out of work and leaving many poor families hungry. "Our long run total cost of COVID and the quarantine both to the present and future society -- meaning our children and our grandchildren -- will reach 41.4 trillion" (pesos, or $810 billion), Economic Planning Secretary Karl Kendrick Chua said. The figure is more than twice the Philippines' gross domestic product in 2020, which the World Bank estimates at $361.5 billion. The losses would be felt over the next 10 to 40 years, Chua said. Consumption, investment and tax revenues would struggle to recover as social distancing rules prevent key sectors, such as tourism and restaurants, from fully reopening. Lower productivity caused by death, illness or lack of schooling during the pandemic "is likely to be permanent", he added.
Got that? Bluntly put, it will take more than a decade to pay for the COSTS of public policies using COVID-19 as a pretext!
Though unstated, capital consumption from current debt-financed consumption, aside from economic restrictions, signifies primary reasons for the prolonged healing of the economy.
Writes economist Antony Mueller,
An insidious form of capital consumption takes place through government debt accumulation. A budget deficit means that the overall volume of national savings falls. Fewer savings imply that economic investment potential has become smaller. In the economic statistics, the expenditures — whether they are from the state or from the private side — count equally as a contribution to the national product. Yet while the spending benefits the current receivers of the government expenditures, the lower capital formation will later show up in weaker economic growth and punishes all.
Antony P Mueller, How Countries Fall into the Welfare Trap March 30, 2019 Mises.org
III. Scandinavian Nations Lifts ALL Covid-19 Curbs!
And puh-leeze, stop using COVID-19 as an excuse.
By lifting all COVID-19 restrictions, Scandinavian nations (Denmark, Sweden and Norway) have opted to live with the virus!
From Yahoo, September 25: Norway will reopen society on Saturday, the government said, ending its coronavirus-curbing restrictions, which have limited social interaction and hobbled many businesses. The Nordic nation joins a small but growing number of countries, including Denmark and Britain, which have removed all domestic restrictions limiting the spread of the coronavirus.
COVID-19 cases surged in Norway, peaked in early September, but have since dropped sharply. Paradoxically, this surge came in the light of a fully vaccinated population share of 68%. (Figure 2, lowest windows) (charts from Our World in Data)
Though caseloads have been down, Scandinavian nations have not eradicated COVID-19. But these countries have opted to cohabitate rather than subject the populace to unsustainable repression.
That is except for Sweden, which has been an outlier in embracing social distancing policies or has remained relatively liberal (no rigorous lockdowns) throughout the previous COVID outbreaks.
Policy responses to the pandemic have not been "one-size-fits-all."
IV. Stagflation Ahoy! Supply Dislocations Meets Too Much Money Chasing Too Few Goods
Figure 3
In the above, we explained how government contributes to consumption. Now we make the case of "Too much money chasing too few goods."
"Too much money chasing too few goods" is typically defined by the mainstream as demand-pull inflation. The other mainstream definition of inflation is cost-push inflation, which consists of increases in wages and costs of raw materials.
From our viewpoint, inflation is fundamentally an expansion of the money supply (quantity and money substitutes).
However, even though I am not a fan of the mainstream, their categorization of inflation has been made somewhat relevant by the present political conditions.
We shall use excerpts from the current news or reports to exhibit the deepening case of stagflation.
Stagflation. Too few goods from supply chain disruptions. From IHS Markit, October 1: “Production volumes fell during September, marking a six-month sequence of decline. Firms continued to indicate that the remaining COVID-19 restrictions hampered production. That said, the rate of contraction slowed considerably from that seen in August. Those companies registering higher output levels mentioned a resumption in factory operations…. Supply chains continued to be impacted by international COVID-19 restrictions during September. In addition to the pandemic, there were reports of port congestion, freight delays and container shortages. With the exception of the marked decline seen in the previous survey period, lead times were extended to the greatest degree since August 2020.”
Stagflation. Declining output or stagnation, and employment losses. From IHS Markit, October 1: “Similarly, new orders declined further, but at a softer pace during September. Anecdotal evidence revealed a general reluctance to spend among clients amid ongoing restrictions. Meanwhile, after falling sharply in the previous survey period, there was broad stagnation in new export sales. A combination of weak consumer demand, ECQ measures and voluntary resignation left manufacturing firms in the Philippines with lower staffing levels. Headcounts have now fallen in 20 of the last 21 months with the overall rate of decline solid in September
Stagflation. Cost-Push Inflation from supply chain disruptions. From IHS Markit, October 1: Turning to prices, raw material scarcity, container shortages, higher shipping fees and unfavourable exchange rate movements were among the key drivers of rising costs, according to panel members. The rate of input price inflation moderated for the fifth month running, but was still quicker than the long-run series average. This, in turn underpinned an increase in selling charges as firms sought to pass on part of the burden. However, the rate of charge inflation was weak in the context of historical data. Firms that lowered their selling prices mentioned efforts to encourage sales.
Stagflation. Too much money. From the Businessworld, October 1: BANK LENDING recovered in August to register its first annual growth after eight straight months of decline, backed by a rise in production loans and reflecting the transmission of the regulator’s rate cuts in 2020. Outstanding loans issued by big banks grew by 1.3% year on year to P9.487 trillion in August, based on preliminary data released by the Bangko Sentral ng Pilipinas (BSP) on Thursday. This is a turnaround from the 0.7% decline in July. … Meanwhile, domestic liquidity grew at a quicker pace in August, supported by the expansion in bank lending. M3 — which is considered as the broadest measure of cash in an economy — expanded by 6.9% year on year in August, picking up from the 5.9% in July, BSP data released on Thursday showed. (Figure 3, topmost pane)
Absent bank lending, the historic injections by the BSP to the banking system functioned as the primary source of liquidity for the financial system.
Again, in August, the BSP’s net claims on the NG increased 23.5% YoY, which means there are now TWO sources contributing to the money supply growth. (Figure 3, middle pane)
The slight pickup in demand from select client industries of banks will piggyback on the government and the banking-financial sector.
Needless to say, faced with supply chain bottlenecks, operation shortfalls, material shortages, and mobility gridlocks, these 'green shoots' in bank lending that has spilled over to money supply expansion will likely spur a conflagration on prices in the economy.
An escalating rate of the CPI (statistical inflation) will thus emanate from demand-pull PLUS partial cost-push (except wages)!
Back in June, I wrote that… (bold and italics original)
As previously noted, supply shocks are indeed transitory when prices and markets are allowed to function normally. But this has not been the case today.
That said, despite the supply gridlocks, the actions of the BSP will most likely determine the performance of the CPI.
Should the BSP sustain its current thrust to sop liquidity off the system, the CPI may see a slight downtrend thru the close of 2021. But a lower CPI would drag down the GDP, increasing credit delinquencies in the banking system.
However, if the BSP reverses, the CPI may likely find sufficient footing for a higher bounce. It would raise rates, sending credit alarm bells to the banking system.
Self-evidently, the BSP is trapped. Damned if you do, damned if you don’t.
The mixed performance of the Treasury markets suggests that they believe that the BSP's liquidity drawdown will be temporary. Or, perhaps treasury traders will soon act on it.
Nevertheless, despite the vehement denials, the economic environment will continue to be dominated by forces of stagflation.
Stagflation Rules! BSP Pulls Back QE and Liquidity! The Peso’s Purchasing Power Declined by 22% in the last 9-Years June 6, 2021
The BSP is trapped. Proof?
From the ABS-CBN, September 27: The Bangko Sentral ng Pilipinas said there are limits to how long the country can keep government spending high and interest rates low to support the economy amid the continuing disruptions of the pandemic... Diokno has maintained that the Philippines’ monetary policy will continue to be accommodative until the country’s economic recovery has become more stable. But keeping interest rates low longer than needed has its risks, he said. “Loose monetary policy and accommodative macroprudential policy and regulation tend to engender potential bubbles in markets that could lead to macrofinancial risks and instability. Once the accommodations are phased out, more scars could emerge,” Diokno said. But he also said raising interest rates “prematurely” has its own risks. “On the other hand, premature tightening could forestall recovery and leave a trail of economic scars also.”
Between the proverbial devil and the deep blue sea best describes the BSP's predicament.
Behold! Witness Nobel Laureate Friedrich A. von Hayek’s Fatal Conceit in Action:
The curious task of economics is to demonstrate to men how little they really know about what they imagine the can design.
The risks of policy errors that gamble with the lives of the citizenry continue to mount.
The PSA is due to announce the CPI this week.
Treasury traders, mostly from domestic institutions, have been pricing in a steeper increase in the CPI through the accelerated widening of spreads, evidenced by the BVAL 10-year rates. They have been far more accurate in predicting inflation than their in-house pin-the-tail-on-the-donkey analysts. (Figure 3, lowest two windows)
And if these traders are correct once again, the BSP will be forced to raise rates sooner than later.
Not only will lending once again contract, expect increased pressures on their balance sheets of the banking system, despite the current bailout policies from the BSP.
V. Will The Recent Surge In Global Inflation Escalate Domestic Price Pressures?
With inadequate domestic supplies, variable exogenous risks magnify the innate fragility of the domestic economy.
For instance, imbalances brought about by policy restrictions have caused dislocations in global trade and investments.
International business groups have launched a protest on incessant interventions of global policymakers.
From the Financial Times, September 30: Global supply chains are at risk of collapse unless governments worldwide restore freedom of movement to transport workers and give them priority over vaccines, a coalition of international business leaders has warned. In an open letter to heads of state and government attending the United Nations General Assembly, the International Chamber of Shipping and other transport groups warned that almost two years of travel bans and other restrictions had had an “enormously detrimental impact on [transport workers’] wellbeing and safety”. The “mistreatment” of workers was piling pressure on the already “crumbling” global supply chain, they said, adding that any failure to act was likely to exacerbate shortages of essential goods including electronics, food, fuel and medical supplies ahead of Christmas. Pandemic border restrictions, distancing requirements and factory closures have all wreaked havoc on traditional supply chains, leading to congestion at ports, delivery delays and soaring freight rates on the main shipping routes between China, the US and Europe. A shortage of transport workers had piled on the pressure, the organisations warned, and was only expected to get worse.
Protect the people from the pandemic by destroying the economy? The law of unintended consequences, anyone?
The concern isn't only the disruption of the economic process flows. The more pressing issue is the ability of enterprises to conduct financial or business calculations under such an uncertain environment.
Such regime uncertainty impairs the ability of commercial establishments to forecast changes in demand productively, which subsequently corrodes their business continuity and expansion plans that translates into resource and labor allocations.
Even more, since politics dictates which and how businesses should operate, the priorities of commercial establishments shifts to regulatory compliance than appeasing the consumers. Or, present conditions skew the economic order from the marketplace to the political sphere.
Of course, like individuals, firms have distinctive traits. Companies that tend to benefit are those with political connections and with easy access to credit. As the weakest links, small and medium scale enterprises are the foremost victims.
And the overlapping interdependence of one node to another affects the entire complex networks of enterprises comprising what is known as the economy. Such escalation of regime uncertainty magnifies the risk environment on a systemic scale, which brings into light the call to action by international shipping and transports groups to restore freedom of movement worldwide.
This account represents the supply shocks presently being experienced around the world.
Again, add the recent record liquidity injections by global central banks that boost demand; we get a perfect storm of surging prices from the cocktail mix of "too much money chasing too few goods caused by supply shocks."
In Europe and China, combine the above factors with a colder weather, an energy crisis emerges.
Figure 4
From Bloomberg, September 27 (gated): This winter, the world will be fighting over something that’s invisible, yet rarely so vital—and in alarmingly shorter supply. Nations are more reliant than ever on natural gas to heat homes and power industries amid efforts to quit coal and increase the use of cleaner energy sources. But there isn’t enough gas to fuel the post-pandemic recovery and refill depleted stocks before the cold months. Countries are trying to outbid one another for supplies as exporters such as Russia move to keep more natural gas home. The crunch will get a lot worse when temperatures drop. The crisis in Europe presages trouble for the rest of the planet as the continent’s energy shortage has governments warning of blackouts and factories being forced to shut….The spike has forced some fertilizer producers in Europe to reduce output, with more expected to follow, threatening to increase costs for farmers and potentially adding to global food inflation. In the U.K., high energy prices have forced several suppliers out of business. (Figure 4, topmost pane)
Move aside Evergrande. Here comes China’s energy crisis!
From the South China Morning Post, September 27: China is in the midst of a power supply crisis that has turned critical in recent days – threatening entire power grids and prompting analysts to slash economic growth forecasts for the year. In the past month, 16 out of 31 provincial jurisdictions – from industrial powerhouses in the south such as Guangdong to the rust belt in the northeast – have rolled out electricity-rationing measures, triggering widespread alarm among much of the population and plunging the nation’s industrial sector into chaos…Analysts have pointed to both a shortage of coal and Beijing’s push to meet emission-reduction targets, and they warn that further disruptions risk aggravating inflation while pummeling production.
China appears to be suffering from an internal slowdown before this energy predicament. Will this energy crisis morph into a financial crisis? (Figure 4 second to the highest pane)
Natural gas prices have reached an equivalent to $190 a barrel of crude oil!
From Bloomberg, October 1: European gas surged to a record 100 euros as China stepped up a global fight for energy supplies, in a move that threatens to derail the economic recovery… Governments are struggling to respond to the crunch, with an increasing number taking steps to try to shield voters from the worst effects of rising prices. France will block any new increase in regulated gas tariffs and cut taxes on electricity, Prime Minister Jean Castex said on TF1 on Thursday…In Asia, the price of liquefied natural gas surged to a record US$34.47 per million British thermal units on Thursday. Both the cost in Asia and in Europe are about US$190 a barrel of crude oil equivalent.
Sad to predict that if this phenomenon persists, a power outage amidst cold winter could lead to many casualties. The most February 2021 Texas Energy Crisis comes into mind (estimated 702 deaths).
More importantly, reduced industrial and agricultural output from such outages could trigger a chain of higher prices across many products, if not shortages. Reduced fertilizer and agriculture output could also increase the risks of a global food crisis.
And yes, the insufficient energy supplies signify a backlash on climate change energy (ESG) politics via "clean energy."
Accelerating inflation pressures have prompted emerging market central banks to tighten monetary policies ahead of their developed economy peers. (Figure 4, second to the lowest pane)
According to the Department of Energy, as of 2019, the Philippines imports 48.6% of its energy requirements consisting mainly of oil and coal. And this won't be limited to energy.
Again, a weak production base translates to increased dependence on imports for domestic supply requirements.
Increases in import prices from the recent surge in global inflation will likely escalate domestic price pressures. It also means that to finance a widening deficit will likely require more USDs, increasing pressure on the peso.
Benchmark 10-years of both the Philippines and the US have been climbing in near synchronicity. But the increase in the yields of Philippine treasuries has outpaced its US counterpart. (Figure 4, lowest pane)
Interesting.
