Now what does this mean? Deficits! This means that the government spends more than it collects in taxes and in borrowing from the people; it means government spending for all those purposes for which the government wants to spend. This means inflation, pushing more money into the market; it doesn't matter for what purpose. And that means reducing the purchasing power of each monetary unit. Instead of collecting the money that the government wanted to spend, the government fabricated the money. Printing money is the easiest thing. Every government is clever enough to do it—Bettina Bien Greaves
In this issue:
Revival of Bank Lending and Public Spending as Drivers of CPI Expansion? Systemic Leverage Explodes!
I. To Boost the GDP, 3Q and 9M Public Spending Surged to Milestone Highs!
II. Mounting Debt Lowers Growth, Magnifies Economic and Financial Risks
III. Banks Impelled to Lend Because of Reduced BSP Subsidies and Limited Opportunities Capital Markets
IV. Systemic Leverage Explodes! Expect Higher Inflation from Expanded Liquidity Growth
Revival of Bank Lending and Public Spending as Drivers of CPI Expansion? Systemic Leverage Explodes!
Early this year, we have raised the issue that supply gridlocks in the face of improved credit-fueled demand would accelerate imbalances in the economy that would surface as increased "inflation."
For instance, last 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.
I. To Boost the GDP, 3Q and 9M Public Spending Surged to Milestone Highs!
From CNN, October 25: The government's fiscal deficit from January to September widened annually, but data from the Treasury bureau show it's still below the government's program. Figures published Monday show the gap between state revenues and expenditures ballooned to ₱1.13 trillion, growing by 29.56% compared to the deficit for the same nine-month period last year. However, it is lower by 20.11% than the adjusted ₱1.42-trillion target. Spending rose to ₱412.4 billion in September, reflecting the ₱10-billion transfer to the Coconut Farmers and Industry Trust Fund in line with the coco levy law or Republic Act 11524 according to the agency. This brought the year's expenditures so far to ₱3.37 trillion, representing an 11.7% year-on-year growth but still short of the revised ₱3.56 trillion target for the period.
Figure 1
Third-quarter and the nine-month public revenues grew by 8.21% and 4.37%, respectively. The aggregate nine-month revenue, which amounted to Php 2.237 trillion, was just off by 3.8% from the 2019 all-time high.
Meanwhile, public spending jumped 15.95% in the 3Q and 11.7% in the nine months of 2021, representing milestones for the respective periods.
The substantial boost in public spending will likely be the principal driver of the 3Q GDP. The PSA will announce 3Q GDP on the 9th of November. Since 2016, public spending has played a primary role in the GDP.
Given the above, the ensuing fiscal deficits of 3Q and the 9-months are all unprecedented in scale.
Figure 2
Nonetheless, authorities raised a historic Php 2.33 trillion from January to September while retaining a record cash balance of Php 761 billion.
With a monthly increase of Php 274.53 billion, outstanding public debt raced to a record 11.92 trillion. Outstanding debt grew by 27.2% or Php 2.548 trillion YoY and 21.6% or Php 2.122 trillion YTD.
Public debt stands at 65.4% of the annualized 2021 NGDP (1H), a 2006 high!
So the public sector swims in liquidity while the economy continues to scrounge for it.
II. Mounting Debt Lowers Growth, Magnifies Economic and Financial Risks
Nonetheless, the citizenry will have to pay for such liquidity bonanza enjoyed by the public sector through higher taxes (after elections) and the inflation tax that should translate to lower growth.
Even mainstream analysts acknowledges this: (figure 2, middle window)
Aside from these theoretical arguments, there exists another theory that corroborates the existence of a nonlinear relationship between public debt levels and economic growth—namely, the threshold or nonlinear effect theory. According to this theory, increases in government debt levels have positive growth effects when debt levels are low, but these effects become negative when debt levels increase beyond a certain threshold level (Reinhart and Rogoff 2010).
Jack Salmon The Impact of Public Debt on Economic Growth Fall 2021, Cato Journal, Cato Institute
The mainstream sees this as a version of the Laffer curve.
Additionally, it is the future generation (our progenies) that pays for or shoulder such burdens.
From public choice theorist, the American economist James Buchanan, (bold mine)
Taxation is imposed on individuals compulsorily, supposedly in exchange for the government’s direct provision of public service benefits from the expenditure. Borrowing, in contrast, represents a voluntary exchange through which private people give up purchasing power in exchange for the government’s promise to return to them income in future periods. Taxation, therefore, imposes a burden of payment for public services directly on the individual present during the time that the expenditure is carried out. Public borrowing, on the other hand, postpones this burden of payment until later periods. The issue of public debt shifts the cost of public expenditures to “future generations” of taxpayers.
James M. Buchanan, The Public Finances; an Introductory Textbook p.37, Café Hayek
More importantly, since public spending translates to consumption, not only will the private sector be deprived of the productive use of resources, but the misallocation of resources will only add to capital consumption.
Further, as debt and misallocation mounts, credit risk escalates along with it.
At the end of the day, to ease this escalating burden, authorities will continue to use financial repression and the inflation tax that comes at the expense of savers and currency holders.
The record public spending has been partly funded directly and indirectly by the BSP. (figure 2, lowest pane and figure 4, middle window)
When making economic projections, the potential fallouts from these factors don’t seem to exist. These are forces that make future economic scenarios quite interesting, nonetheless.
Paradoxically, despite the current hardships, the appeal of socialism and economic centralization remains robust and may manifest itself in the incoming administration.
III. Banks Impelled to Lend Because of Reduced BSP Subsidies and Limited Opportunities Capital Markets
The public sector and banks have benefited most from the BSP’s historic bailout operations, including unprecedented liquidity infusions, unparalleled monetary policies, and unequaled regulatory, operational, and capital relief measures, and more.
From the Inquirer, October 30: Loans activity at the country’s largest banks grew for the second straight month in September, lending credence to the central bank’s assertion that the financial system has turned a corner after being ravaged by the coronavirus pandemic. In a statement, the Bangko Sentral ng Pilipinas (BSP) said preliminary data showed that outstanding loans of universal and commercial banks, net of their short term loans to the regulator, rose by 2.7 percent year-on-year in September. … Outstanding loans for production activities grew by 4.4 percent in September from 3.1 percent in August, driven mainly by the expansion in loans for real estate activities (7.2 percent); information and communication (26.6 percent); financial and insurance activities (6.0 percent); and manufacturing (4.4 percent).Loans are the primary source of bank earnings. Investments are secondary sources. Banks recently reported enormous profit growth even when they haven’t been lending. Nobody seems to ask how can this happen and why?
Figure 3
Prompted by the BSP’s financial repression, the critical income boost has emanated from subsidies on deposit expenses, which are implicitly paid for by depositors. But like any policy, it is haunted by diminishing returns. Moreover, the elevated rate of statistical inflation has shackled the BSP from further lowering of policy rates.
Additionally, the historic QE operations of the BSP appear to be slowing.
Ironically, banks have started to lend even as they continue to add to their loan loss provisions, and (published) NPLs are at multi-year highs (as of August). (Figure 3, upmost pane)
Why so?
Aside from diminishing returns from BSP subsidies, rising bond yields translate to investment losses on their fixed income portfolio. We expect to see bank holdings of Held-to-Maturity (HTM) rise.
Furthermore, with reduced earnings opportunities from fixed income, the other remaining channel for investment is in the stock market. Bank lending to the financial sector has coincided with the recent boom in the PSEi 30. (Figure 3, middle window)
Again, in short order, the only option for banks to generate cash flows and earnings in the face of reduced subsidies and limited opportunities in the capital markets is to expand lending, regardless of the risk environment.
And because of this, the BSP claims victory in its policy. The BSP looks to be arm-twisting banks to rekindle confidence or the animal spirits. Good luck to them.
IV. Systemic Leverage Explodes! Expect Higher Inflation from Expanded Liquidity Growth
There are many reasons why people borrow.
Some to bridge finance operations, many to pay existing debt or debt rollovers, others for capital expansion, some to pay dividends, other to finance speculations, etc.
It is unclear whether the current bank lending revival is about productive undertakings or representing portfolios intended to buy time.
What is clear is that system leverage continues to escalate under very uncertain conditions. Growth of system leverage, public debt, and universal bank credit jumped 15.61% to a record Php 20.914 trillion! System leverage accounts for 111.2% of the GDP. (figure 3, lowest pane)
Figure 4
And this time, both the public and private sectors will power liquidity growth as supply networks remain handicapped by gridlocks, bottlenecks, and material shortages. (Figure 4)
From the BSP, October 29: Preliminary data show that domestic liquidity (M3) grew by 8.2 percent year-on-year to about ₱14.6 trillion in September 2021. This was faster than the 6.9-percent growth posted in August. On a month-on-month seasonally-adjusted basis, M3 increased by 1.3 percent. Domestic claims expanded by 7.6 percent year-on-year in September from 6.7 percent in the previous month due to the increase in net claims on the central government as well as the continued improvement in bank lending to the private sector. Net claims on the central government rose by 24.3 percent in September from 23.4 percent (revised) in August on the back of sustained borrowings by the National Government. Claims on the private sector, driven by bank lending to non-financial private corporations, went up by 3.1 percent in September from 2.4 percent (revised) in August.
Improved demand funded by mostly bank credit in the face of supply constraints translates to higher prices ahead.
As a side note, which data are we supposed to believe: The debt numbers of the PSEi 30 that has declared accumulation continued to grow through the 1H of 2021, or bank data indicating contraction on lending?
And that’s from the local scenario alone. How about the influence of global inflation on domestic prices and production?
Of course, there is a caveat: The exception emerges from the rising possibility of a coming sharp downturn in demand, as indicated by last week's abrupt flattening of yield curves in the bond markets of major economies.
