The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved—Ludwig von Mises
In this issue:
Ka-Boom! The Peso Falls to an ALL-Time Low! Bank Salary Loans Explode! Bank Credit Card Portfolio Zooms!
I. Ka-Boom! The Peso Falls to an ALL-Time Low!
II. Misplaced Blame on Exogenous Forces
III. Buildup of USD Shorts: The Derivative Chickens Come Home to Roost!
IV. Did the BSP Sacrifice Evading Moral Hazard to Save Vested Interest Groups?
V. How BSP Rescue Policies Restructured Banking Operations
VI. Balance Sheet Entropy Spreads to Low Income Consumers: Salary Loans Explode! Consumer Credit Card Hits Fresh Records!
VII. Socialization of Investments: Near Record Fiscal Deficit, LGU Spending Boom, and Milestone Debt
VIII. BSP’s Bias of Easy Money: Free Money for Politicians via Debt and Inflation Financed Deficit Spending
Ka-Boom! The Peso Falls to an ALL-Time Low! Bank Salary Loans Explode! Bank Credit Card Portfolio Zooms!
I. Ka-Boom! The Peso Falls to an ALL-Time Low!
Businessworld, September 2: The peso tumbled to a record low, boosting pressure on the central bank to raise interest rates more aggressively to stem the slide.
Ka-boom! The Philippine peso hits an all-time low!
We foresaw this.
Furthermore, to reduce credit risk through the exchange rate channel, the BSP has used derivatives and loans in shoring up its Gross International Reserves (GIR), thus helped in the powering up of the peso. Other Reserve assets continue to absorb a significant role in the BSP’s GIR.
…
Should a surge in global inflation continue, this massive USD short position can be expected to unwind dramatically.
*See BSP’s Diokno: No Asset Bubbles and Excessive Credit Growth; Ex-BSP Gov. Espenilla’s Minsky Moment, and Statistical Inflation of Real Estate Prices February 22, 2021
First, let us discuss some technicalities of its price trend.
Figure 1
After its failed first attempt to breach the October 2004 acme of Php 56.45 last July, the USD Peso barreled through the same resistance level to carve a new high for the USD (low for the peso) at Php 56.77 last Friday. (Figure 1, topmost and middle window)
More importantly, the USD peso broke through a 2020 or two-year and a 2009 13-year trendline ceiling, possibly indicating a tailwind for the present momentum, which makes Php 60 a beckoning psychological goal.
And should the USD peso maintain the present level or push forward through the month's end, it would not only reinforce its 52-year uptrend but also exhibit acceleration of its upside velocity. (Figure 1, lowest chart)
II. Misplaced Blame on Exogenous Forces
Next, don't blame external forces for the blight of the peso.
Figure 2
In Asia, the Philippine peso (-1.3%) was the third worst-performing currency of the week after the South Korean won (-2.3%) and the Thai baht (-1.9%).
Year-to-Date (YTD) and Year-on-Year (YoY), the Philippine peso is only next to South Korea as the region's laggard. (Figure 2, topmost pane)
While events abroad have partly contributed to it, domestic economic and financial conditions signify the primary factors for its frailties.
While technically, the Philippines represents a cluster of 7,640 islands, its economy is interdependent with the global economy.
Primarily, the USD standard anchors the domestic monetary system via the BSP's balance sheet. Or, the USD holdings of the BSP administer the expansion of peso liabilities. (Figure 2, second to the highest pane)
Furthermore, the Philippines relies heavily on the world for OFW remittances, merchandise trade, tourism, foreign direct investments, portfolio and credit flows, and more.
The trailing position of the Philippine peso relative to the region, thus, exhibits structural internal shortcomings or deficiencies.
So, blaming external forces for the blemishes of the exchange ratio of the local currency may be misleading. Instead, it signifies a sign of denial through self-attribution bias.
III. Buildup of USD Shorts: The Derivative Chickens Come Home to Roost!
One of my concerns with the BSP is that they haven't been as transparent as the previous website. For instance, the BSP has abbreviated the history of the minutes of monetary policies, shortened the time coverage of the CPI, delayed the updates of its balance sheet, and more.
Based on the March 2022 data, after the violation of the tight range of holdings due to the QE the BSP launched, its FX assets haven't recovered their previous state.
The implication is that, as stated here elsewhere, the insufficient USD holdings backing its aggressive peso "printing" or issuance to rescue the banking system should lead to a substantially LOWER peso.
The next factor is that even while the BSP flaunted its Gross International Reserves (GIR), the increases emanated from OTHER RESERVE ASSETS (ORA) or variable derivatives. (Figure 2, second to the lowest windows)
Or, "borrowed reserves" enabled and facilitated by low rates abroad boosted its GIR. The IMF's data template on International Reserves and Foreign Currency Liquidity (IRFCL) exhibits this.
Furthermore, the national government has ramped up its external debt for various political purposes (infrastructure, pandemic, etc.).
For these reasons, authorities expanded its "short position" against the USD.
But surging rates abroad have rendered holding derivatives costly.
And the facade of the strong peso crumbled when the BSP reduced its exposure of its ORA.
As a proxy to its balance sheet, the growth rate of the Net Foreign Assets (NFA) of the BSP dropped like a stone since January 2021. This cascade has resonated with FX holdings of financial institutions, represented by Other Depository Corporations (ODC). (Figure 2, lowest pane)
Needless to say, having been "short" the USD, rising rates abroad translates to the proverbial chicken coming home to roost.
Finally, to cushion the decline, the BSP has skewed its FX balance sheet management towards external borrowing from the central government.
IV. Did the BSP Sacrifice Evading Moral Hazard to Save Vested Interest Groups?
Next is the fundamental or the actual health of the economy.
The primary culprit for the dilemma of the peso is no less than the BSP's unprecedented inflationary "credit expansion and monetary printing" regime.
And the preeminent symptoms are the fiscal and trade deficits or the credit-financed "twin deficits," representing overspending, implicit redistribution, and resource misallocations.
Rising rates imply that the diversion to unproductive and unsustainable wealth-consuming activities will likely grind to a halt. The current bubble structure thrives on the eternity of a low-rate regime.
Its cessation should help restore the process of wealth regeneration.
However, the BSP forgot that humans are driven by "incentives."
And the privileged vested interest groups take unnecessary risks in the understanding that the BSP has their backs where failure is not an option. And that monetary authorities will mount another round of rescue.
The policy-skewed incentives signify the "moral hazard," which the BSP is aware of, yet they implement policies ignoring it. (Espenilla Jr. et.al, 2005)
V. How BSP Rescue Policies Restructured Banking Operations
It wasn't the pandemic that stalled banks from their core operations, lending.
Instead, the long-term buildup of unproductive lending led to a tipping point, which the 2018 spike of the CPI exposed. The attendant yield surge compelled the BSP to tighten. The uptrend in Non-Performing Loans (NPL) started to pick up speed.
In response, the BSP chopped reserve requirements, engaged in unorthodox GIR management via the ORA, and reversed course in its monetary policy through rate cuts as part of its program to revert to the easy money system.
The repressed policy rates subsidized bank deposit expenditures that provided the industry accounting profits.
The pandemic only provided the convenient political pretext to magnify its rescue efforts with historic liquidity injections and unprecedented relief measures, covering operations, regulations, and capital requirements.
Figure 3
Since 2018, bank operations reconstructed from lending to "investing." (Figure 3, topmost pane)
While the lending share of total assets plateaued in 2018 and descended through the present, the proportion of investments soared!
But these investments soured with the resurgence of the CPI and yields across the yield curve. Bank Held to Maturity (HTM) assets skyrocketed! (Prudent Investor, August 2022)
With narrowing opportunities from the investing corridor, the revival of lending was the only recourse for banks. So the present gambit.
Hence, the relief measures provided the most critical disguise for the industry's deteriorating balance sheets.
But disguising risks doesn't extinguish them.
Aside from transferring to other entities (taxpayers and currency holders), maladjustments accrue. While its eventual outcome gets kicked down the proverbial road, it results to even more volatility and disorderly adjustments.
Rising rates are bound to amplify credit impairments of the bank's portfolio. Hence, the banks will become even more dependent on the statistical masquerades.
As one would note, because there is no such thing as a free lunch, the peso has functioned as a ventilation outlet for such invisible transfers.
Therefore, rescues intended as a temporary measure may become a permanent feature.
As the great Milton Friedman wrote,
Each recession has produced government spending programs supposedly as a temporary device to create jobs. But nothing is so permanent as a temporary government program. Those programs have typically moved into high gear only after the economy was on the road to recovery. In the process, they have established an interested constituency that has lobbied for their continuation, thereby contributing to the upward trend in government spending. (Friedman, 1984)
VI. Balance Sheet Entropy Spreads to Low Income Consumers: Salary Loans Explode! Consumer Credit Card Hits Fresh Records!
Also, please observe the shifting structure of bank credit expansion.
Yes, bank lending expanded 12% YoY last July but was marginally down month-on-month.
The striking portion of the BSP data is that the most substantial growth in the bank's portfolio emanated from consumers, which eclipsed production loans!
In particular, salary loans catapulted by an incredible 23.63% MoM to a record Php 105.9 billion! It was up 39.2% YoY! (Figure 3, second to the highest window)
In the meantime, consumer credit card loans jumped 1.83% MoM and 21.04% YoY to an unparalleled Php 487 billion! (Figure 3, second to the lowest window)
The frantic use of credit cards to augment the sharp decline in real income/wages represents a global phenomenon!
Consumers in the US and UK have escalated the use of credit cards.
Astounding.
Remember the rising rates of self-rated poverty and poverty incidences? Or the shallow improvements in the labor force?
The spike in salary loans suggests that people with little access to credit cards resorted to loans from salary loan providers registered with the BSP.
So aside from those with access to credit cards, the data suggest that even low-income people, possibly minimum wage earners, have increased leverage on their balance sheets to maintain their lifestyles or to survive.
And this excludes accounts of salary loans directly from employers.
Remember, the CPI is still below 2018 levels.
Yet, paradoxically, many statistics of banks and the financials, which are sensitive to street inflation, are at historic highs. These include some Treasury yield spreads, the most aggressive BSP rate hikes, the spike in Held to Maturity assets, credit cards, and salary loan data, and others.
In the real world, the scarcity of agricultural products has not only increased but has spread to sugar, onions, salt, and others.
Aside from drought and the energy crisis causing production dislocations that reduce output in many parts of the world, the escalating protectionism in the rice trade appears to worsen domestic scarcities in rice supply.
Prices of rice exports are due for an increase from the production slowdown brought on by the massive drought in China. Meanwhile, India is considering an export ban as Vietnam and Thailand have agreed to raise export prices soon. These nations constitute the four biggest suppliers of domestic rice imports.
Do these seem like signs of peak inflation?
Such scarcities represent a glaring revelation in the embedded imbalances of investments/resource allocations toward credit-financed asset bubbles at the expense of the heavily protected agriculture industry.
And yet, how is the CPI representative of reality?
The BSP's goal of raising rates is to curtail demand by downscaling credit usage. But instead, consumer credit usage for consumption rockets!
How is the surge in bank consumption lending not fueling higher prices?
And the escalation and diffusion of balance sheet gearing from banks to non-financial corporates to small businesses to consumers in the face of rising are supposed to be "growth" enhancing? Really?
Remember, these account for the private segment of "domestic demand" on the forthcoming GDP!
But there is more.
Expansionary public and private sector credit also benefited the financial sector.
Figure 4
Bank lending to the financial sector surged 1.6% MoM and 8.13% YoY in July. As we have been pointing out here, the credit surge in this sector may have constituted margin trades on financial assets. The equity benchmark, the PSEi 30, rebounded 2.61% MoM.
Bank lending flows appear synchronized with fluctuations of the PSEi 30.(Figure 4, topmost window)
The pickle is that the record low peso has been exposing such veneer.
And that's just from the banking and financial side.
VII. Socialization of Investments: Near Record Fiscal Deficit, LGU Spending Boom, and Milestone Debt
The previous administration solidified the embrace of the Keynesian blueprint of "socialization of investments" for its economic development paradigm.
The economist John Maynard Keynes wrote: "a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative." (Keynes, 1936)
In this respect, to achieve full employment or economic nirvana, authorities dictate and control directly and indirectly through Private Public Partnerships (PPP) the allocation of resources for its political objectives. That is aside from public spending on maintaining and expanding the bureaucracy.
With credit bubbles in the private sector fueling trade deficits, the deficit spending of the public sector represents the proverbial icing on the cake, thereby the "twin deficits," which are presently at milestones.
Inquirer.net, August 26: The national government posted an end-July budget deficit of P761 billion, lower by almost a tenth than year-ago level and more than a fourth smaller than the seven-month program as revenue collections exceeded targets while agencies continued to underspend. Citing the latest Bureau of the Treasury (BTr) data, Finance Secretary Benjamin Diokno told the House committee on appropriations Friday that the fiscal deficit in the first seven months was 9.1 percent narrower than the P837.3 billion recorded a year ago. It was also 26.6 percent smaller than the P1.04-trillion deficit program for January to July.
Based on targets, perhaps the government underspent. But from a historical standpoint, the 7-month spending has raced to record levels, with July's paltry 4.8% growth providing the oomph! (Figure 4, second to the highest window)
As a result, while the Php 761 billion deficit Year-to-Date may be about 10% lower than the record 2021 Php 837 billion, it is the second highest ever. It even topped 2020, the pandemic year! (Figure 4, second to the lowest pane)
Here is the thing.
The post-election local government spending spree soared anew, which jumped by 29.7% in July. It filled the gap from the 10.2% deficit incurred by the central government.
Or, LGU spending in pesos reached unprecedented levels! (Figure 4, lowest pane)
Sure, part of this must be a product of the implementation of the Mandanas Ruling that allows LGUs to have a larger share of the national tax collections. This decree took effect at the start of 2022.
LGUs not only spent their allotments but also indulged in record borrowing in the 1Q, mostly from state-owned banks.
And with the windfall, LGUs have likely caroused on election-related and post-election activities.
VIII. BSP’s Bias of Easy Money: Free Money for Politicians via Debt and Inflation Financed Deficit Spending
But it would be misleading to perceive increases in tax collections as "growth."
This is an example of the "money illusion" or the tendency to infer data based on nominal terms rather than in an inflation-adjusted context.
Figure 5
Since the basis of sales and excise taxes are transaction prices, the upside of the CPI has mirrored the growth of these taxes. (Figure 5, topmost and second to the highest windows)
The first takeaway, higher inflation benefits the government directly through tax channels.
Next, the accelerating uptrend backed by the record surge of public spending has almost been symmetric with the upswing in the CPI. (Figure 5, second to the lowest window)
But public spending is inflationary only when financed by the banking system or the BSP.
Sure enough, banks continue to pile on claims on the government, which hit a record last July, while the BSP appears to have tacitly resumed its QE. Yes, BSP’s net claim on the central government was down 20.3% YoY but up 15.18% MoM.
Besides, the swelling deficit has caused public debt to swell to Php 12.89 trillion this July.
The more significant takeaway is that the government benefits from deficit spending primarily from low rates and inflationary financing.
Thus, the BSP insists on keeping rates below published inflation or sustaining a regime of negative 'real' rates. It wants to use the inflation tax to subsidize the escalating accervation of debt from deficit political boondoggles spending. It also hopes to sustain debt-financed spending by the private sector (mostly the firms of the elites).
If the BSP insists on this path, the peso shall reflect the inflationary bias of their policies.
Ironically, the era of free money is most likely over.
Once debt-financed malinvestments reach a tipping point, authorities and the private sector will have to scale back and sanitize their balance sheets.
At that point, the ensuing austerity will compel a surge in income and earnings losses and a spike in unemployment, which affects the bubble sectors and the bureaucracy.
And authorities will likely opt for increased tyranny or begin to liberalize the economy.
As a sign of times, South Korea may be the first country to implement a cut in fiscal spending.
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References
Espenilla, Jr. Nestor A., San Pedro, Teodora I., Prenio Jermy Y. Basel 2 and Risk-Based Supervision January 21, 2005, Bangko Sentral ng Pilipinas
Prudent Investor Bank GDP Underperformed in 2Q and 1H; PSEi 30 Banks Boosted Industry Performance, BSP Bailout: The Financial Index Outclassed the PSEi 30! August 28, 2022
Friedman Milton, Friedman Rose, Tyranny of the Status Quo p.115, Harcourt Brace Jovanovich 1984
Keynes John Maynard, The General Theory of Employment, Interest, and Money p.187 February 1936 ISN ETH Zurich
Yours in liberty,
The Prudent Investor Newsletters
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Nota Bene: The newsletter intends to apprise readers of the market conditions based on the information available at the time of the items’ writing, whose accuracy and timeliness of the issues concerned are subject to change without prior notice. Solicitation to trade is neither intended by the contents. In the meantime, the discussion of occasional positioning on particular issues are opinions of this author.
