The record of governmental attempts to control wages and prices is clear. Such efforts have been made in one form or another periodically in almost all times and all places since the very beginning of organized society. In all times and in all places they have just as invariably failed to achieve their announced purposes. Time after time an historian has laconically concluded, “…the plan to control rising prices failed utterly." Or, "... the laws were soon repealed since no one paid any attention to them." Robert L Schuettinger and Eamonn F. Butler, FORTY CENTURIES OF WAGE AND PRICE CONTROLS: How Not To Fight Inflation p.147 Heritage Foundation
In this issue:
Phisix Breaks 6,900 as Inflation Risk Becomes a HOT Political Issue!
-Media’s Conditions the Public on Coming Price Controls
-The Dangers of Price Controls
-Emancipate the Pricing System from Politics
-More of Media’s Bait and Switch
-WHY The Establishment’s Aggregate Demand Policy Denial?
-Beneficiaries of Inflationism Will Always Defend the Status Quo
-Philippine Banking Loans Explode Higher as Liquidity Drops!
-BIS to BSP: Raise Interest Rates!; On the 6,900 Phisix Breakout
Phisix Breaks 6,900 as Inflation Risk Becomes a HOT Political Issue!
First, a deafening code of silence. Next, a visible shift in gears: plausible deniability.
Domestic price inflation has finally hit mainstream headlines! Not only once but thrice this week as shown on a leading newspaper.
This posits that inflation risks have emerged to become a key socio-political concern. And this uncovers one fundamental reason behind the Philippine central bank or the Bangko Sentral ng Pilipinas’ (BSP) move to cram four policy measures in less than months.
And as I rightly raised, If inflation and financial stability risks have indeed been operating within the ambit of the BSP’s policy parameters as so promulgated, then WHY has the BSP shoehorned (four) macro prudential measures in less than three months???[1]
Media’s Conditions the Public on Coming Price Controls
Yet media’s response has been to mechanically deny its perils. And as always, culpability has been imputed to “supply shocks”, particularly logistical gridlock, hoarding and price manipulation.
At the week’s start, “Manila’s truck ban” as well as by a supposed “tightening of customs and transport regulations”[2] has been pinpointed as forces primarily responsible for the substantial price increase in agricultural products.
Truck bans, which limit transportation to certain hours, only divert schedules for shipments. Since truck operators and business establishments will reschedule to conform to the permitted time, the impact from fresh political mandates would likely be apparent only at the onset of newly imposed mandates and thus would hardly have lasting effects. Though, of course, such mandates would imply higher costs of shipments, which are likely to be passed on to consumers on a one-time basis, to suggest that this would have material influence to a succession of substantial price increases would be a dubious, if not a preposterous proposition.
And yet how could a “Manila truck ban” affect NATIONAL prices? Have all sources of agricultural products been centrally sourced and networked from the country’s capital?
As a side note, in India, the second largest producer of onions in the world, onion prices has been sky bound with wholesale prices spiraling 80% this week alone! Has this been due to Manila Truck Ban too? How about the escalating prices of “onions, garlic and chicken meat and eggs” in Indonesia? As a reminder the Indonesian government raised interest rates 5 times from 5.75% to 7.5% in 2013.
How about the Malaysia government’s imposition of price controls spanning 18 agricultural products due price pressures? Have all these been due to “Manila truck ban”?
My point is not only to expose on the post hoc fallacy of media’s claim, but to likewise demonstrate of the accelerating risks of price inflation that has reared its ugly head in Asia.
The inflation Godzilla has been unleashed here and abroad, so it will take dramatic measures, which runs opposite to current conditions, to contain them.
But because the establishment has been hooked to old boom time conditions, they will resort to everything else from political public relations (PR) campaign, policy gimmickry and various social controls such as price and wages controls, trade controls, financial controls, travel and mobility controls, etc… just to be able to defer from attending to the real cause: credit expansion brought about by manipulated interest rates.
Recently I warned[3] that “inflationism have always been a part of the grand scheme of manifold interventions imposed on society”, noting that the political trends in the Philippines might head in the direction of Argentina. Well signs of the Argentina political paradigm have been in place.
And as predicted, with food inflation now a media sensation, politicians have increasingly been urging for tighter price controls!
Grandstanding politicians have already embarked on a populist witch-hunt. They have already condemned faceless ‘greedy’ traders for hoarding and price manipulations, specifically for imported garlic where prices has allegedly zoomed to Php 300 from Php 17 based on an undisclosed timeframe[4]. The acceleration in garlic inflation intensified this year as shown above.
In the case of rice, we have been told that farm gate prices and market prices have widely deviated due to “hoarding”[5].
Yet media never asks, what’s the authentic cause for such pricing imbalances to exist? Has such been due to the absence of competition? Why has rice distribution been a quasi-monopoly? What has enabled the absence of competition and or the monopolistic distribution structure of the rice industry? Hasn’t the National Food Authority been a big factor in the maintaining the populist politics of rice protectionism bannered as “self sufficiency”?
As I previously noted[6], In case you haven’t you noticed, on the surface, despite instituted political controls, rice prices have partly been adjusting to reflect on market conditions. But the symptoms of dislocations from the miscellany of political interventions (demand and supply side) have been surfacing via increased supply side strains compounded with the growing financial pressures on the government.
The same applies for food imports, what has been the cause for the limitations of imports?
Haven’t the critical areas—where the inflation rage has become a populist sensation—been covered by the Price Act (REPUBLIC ACT NO. 7581)[7] which means that these items have been monitored, regulated or under selective price controls by the government? What happened to earlier government controls??
Yet the initial failure of government controls should lead to more government controls??? Failure is to be REWARDED???
Since as I earlier noted that “market price flexibility has been taken off the table” due to price controls, doesn’t this also entail that supply side factors will also be impeded?
Aren’t we just simply witnessing the unintended consequences of the political actions of the past now haunting us?
The Dangers of Price Controls
The establishment would like to make the public believe that consumers have little or no brains, therefore limited choices, for them to fall prey to the predations of price schemers. And the “noble” and “just” politicians will deliver us from the clutches of oppression.
Such a storyline may have popular appeal or sound heroic that would make for a great feed for the showbiz industry, but this is not the way things work in the real world of scarcity.
But what can politicians really do? Politicians live, breathe and eat based on taxpayer money. Also whatever they spend on depends on taxes, debt or inflation which again represents the yoke of taxpayers and currency holders.
They can legislate or impose decrees or a deluge of controls, where they can use institutional coercion to shake down, incarcerate or eliminate suspected felons, but there is one important thing they can’t do: They can’t produce the required goods or politicians have not been conceived to do production.
And even more important is the natural limits for the actions of politicians. In short, politicians cannot overwhelm or override the fundamental law of economics.
Politicians can certainly do a King Canute (King Gnut was said to have commanded “the tides of the sea to go back" just to show to his fawning courtiers the limits of his powers), but they can’t solve economic problems overtime with merely short term populist actions that comes with nasty long term consequences.
Here is a basic economic Price (vertical) –Quantity (horizontal) chart of price ceilings. The natural market price is represented by Pe. However, the government decrees the price as illegal and instead be placed at Pc. This causes the natural balance between demand and supply Q2 to shift.
Because of artificially low prices, quantity demanded will grow (see Q4). Simultaneously, the restriction profits or income on suppliers will lead to a decline in quantity supplied (see Q1). The variance between Q1 and Q4 or the economic consequence is what is known as SHORTAGES.
So when government imposes price controls there will be shortages. And because price controls leads to shortages, the ramification will be higher implied prices which will be visible on the black markets.
Since the initial actions didn’t work, they will lead to a serial chain of expanding controls to many other items. As I have pointed out above, the failure of previous price controls have prompted politicians to demand MORE price controls. And the result will be the same, more shortages from diminished supply which will be expressed as higher prices via black markets.
There will be a feedback loop between populist controls on the one hand, and shortages and implied price inflation on the other that springs from politically induced distortions in the supply side conditions. Interventions deepen. And if sustained, such will be manifested via massive reduction in stocks of goods for sale which may be seen through empty grocery shelves to even snake line public rationing of goods ala Venezuela.
And because expanding price controls means diminishing supplies, government will act to fill in the gap or cover deficits in such goods. Thus government subsidies will translate to bigger government budgets, higher taxes and even more money printing.
But instead of the banking system doing the printing as today, the burden will transfer to the government via monetization of deficits. This extrapolates to even more imbalances in the economic system.
All these again will be manifested via a weaker peso and higher interest rates
Current activities represent more signs of intensifying stagflation as I have been predicting. Let us see how such dynamics will impact the Filipino consumers. [Yeah more signs of sustainable boom eh?]
Yet price controls begets more price controls which eventually means controls covering other aspects of social activities.
As the great Austrian economist Ludwig von Mises warned[8]:
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 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 devolved upon the government. This is no longer capitalism; it is all-round planning by the government, it is socialism.
Yes government can by fiat command people to produce.
But forcing the public to produce “supply” would translate to a transformation to a command and control economy similar to North Korea, USSR, or Mao’s China or its variant the subcontracting to the private sector of a command and control economy similar to fascist regimes as Nazi Germany or Italy’s Mussolini. As history reveals, command control political economies are bound for doom.
So while socialism isn’t inevitable, as this would depend on the sustainability of current political trends, nonetheless the widespread use of price controls that may expand to cover many other controls is a path towards such direction. This is clearly the case of Argentina and Venezuela.
So there is a huge gap between populist imagery and political economic reality.
Emancipate the Pricing System from Politics
Politicians and media hardly ever tell you that if garlic, rice or other food inflation has indeed been a supply problem, all that needs to be done is to open or liberalize entry of supplies and allow market forces via competition to find its “equilibrium” or natural pricing levels. Price distortions from so-called supply shocks or even from manipulations will thus be temporary. Manipulators will be burned. Greed will be disciplined by sheer market forces. In short, the price mechanism will determine the allocation of resources.
Unfortunately depoliticization or liberalization would encompass the undermining of interests of politically entrenched or connected groups—something which all (present and past) administrations have refrained from dealing with.
But since the ‘invisible hand’ would signify a spontaneous collaboration between consumers, traders, producers and financiers then the resolution of supply dilemma will have no visible heroes from which the public has been hardwired to see and lavish praises on.
Politics without romance is not just about public choice, but also about how markets work. So for the gullible public, who has been oriented to see the visible, allowing markets to function would represent an underdog or long shot bet.
As one can see, the current supply constrains accounts for a structural political-institutional symptom that has plagued the domestic agricultural industry primarily due to over politicization. As I recently pointed out again, “the self-inflicted obstacles in the industry also expose on the depth of sensitivity or vulnerability of the domestic food supply chain to exogenous factors[9]”.
And media’s classical conditioning of placing the burden of price inflation to private sector’s supposed ‘greed’ alarmingly ushers the way for the coming onslaught or manifold interventions in the economy as enumerated above.
Notice too as I mentioned earlier, that since food inflation has not been a Philippine dynamic alone, this implies that politicians and media have trumped up excuses to justify the forthcoming interventions.
As a side note, there will always be unscrupulous people in any society, but competition which allows for consumer’s choice plays an important role in purging them. In addition, unethical behavior, as I pointed out last week, will only multiply if they are rewarded[10]. The important thing is to identify the sources of incentives from these shady practices.
Finally, notice as well that just when media and the politicians have jumped the gun on ‘greedy’ traders, the Bangko Sentral ng Pilipinas released a June inflation report which shows a tempering of official inflation figures to 4.4%[11].
The inflation report reveals that while food inflation continued to rise, non-food items led by electricity oil and gas, recreation and restaurants offset the price pressures in agricultural products.
Two observations from this.
One, if there has been some accuracy in the official inflation figures, then the decrease in price inflation numbers in restaurants (which carries an amazing 12.03% weight of the total CPI basket) plus recreation (1.93% weight) means bad news for the much ballyhooed Filipinos consumers. This could mean that inflation’s income and substitution effect could already be taking hold or having its effect, as observed from a recent poll conducted by Wall Street Journal[12]. In short, consumer reallocation of spending towards necessities means a retrenchment in ex-necessities or ‘want’ goods or services.
The other aspect is obvious for the keen and unbiased observers; why would a 4.4% inflation rate spark such political furor? Go figure.
More of Media’s Bait and Switch
Going back to the logistical gridlock induced price inflation, I am not aware of the detailed list of the supposed “tightening of customs and transport regulations”, though I read of increased tariffs imposed on some goods such as imported garlic (40% duties).
However I believe that any “political clampdown on rice smuggling represents only entertainment value and or another publicity shtick” for the simple reason that politicians depend on rice and food smuggling because such “signifies a veiled subsidy to politicians in terms of prolonging their tenure through the attainment of temporary social stability”, aside from the insurance function “against policy calculation errors”.
Yet if TRUE, increased transport regulations or a supposed tightening by customs may indeed partially contribute to price inflation. But this would be on a one time or on an infrequent basis and NOT on a sustained pace. And these are mostly aggravating circumstances or secondary causes rather than the major driver.
The problem is the sustained, if not intensifying, price inflation pressures.
As a side note, the supposed crackdown in smuggling, which translates to more economic repression (e.g. higher tariffs/duties) will lead to more, not less, smuggling. Political barriers which increases the cost of doing business in the formal economy creates arbitrage opportunities in the informal economy which many will be motivated to exploit, especially the politically connected, thus smuggling will persist.
Yet additional political barriers also imply MORE corruption that will go hand in hand with smuggling. Such corruption will most likely be anchored on technicalities or loopholes from arbitrarily determined legal mandates designed to curtail smuggling. This is because as government piles in to impose a dragnet of controls on commercial activities, which restricts supplies in the formal sector and thereby raising prices, such environment provide a widening of the profit window enough to fund or finance under the table transactions. So the more the interventions, the bigger the black market.
While the supply side has been the focal point of the article, a tinge of the demand side had been raised based on a quote from a prominent chieftain of the industry who reportedly said: “The Philippine economy has been growing at a compounded rate of over 7 percent, which translates to many more trucks for the delivery of goods and more cars because more consumers can afford them. This is a good thing. The problem is there are no additional roads and infrastructure to absorb the increase”
I see severe problems with this assertion. Problematic price increases have hardly been happening during the time when demand was at its peak as seen by 7% statistical growth rate which was logged in at the first semester (or first two quarters) of 2013 plus the last quarter of 2012, but when growth rates have been in a decline.
In short, for such claim to be valid then price pressures should have been more apparent in the first half 2013 rather than the first half 2014. This would seem as a time inconsistent category error.
Yet under a fixed money supply, price increases in one area will be offset by price decreases in another area. This means that price increases will not signify a general phenomenon. But this hasn’t been the case.
The buildup in consumer price inflation pressures (not restricted to food) has emerged in conjunction with a breathtaking 8% leap in 3 bedroom Makati condo units during the 1Q 2014[13] alongside a whopping 9.15% return on the Philippine equity benchmark, the Phisix.
Such has apparently been in response to a sustained jump in the growth rate of money supply which clocked in at a turbocharged 30+% during the second semester of 2013 that extended through the 1Q 2014[14]. The impact from money creation operates on a time lag for the simple reason money circulates in the economy unevenly thus affecting prices relatively.
In other words, the current consumer price inflation signifies a knock on effect from the sustained credit expansion that has been manifested in the incredible growth rate of money supply.
Because of such credit expansion, price inflation has intensified and spread from financial assets to economic goods.
WHY The Establishment’s Aggregate Demand Policy Denial?
WHY the establishment’s denial? Hasn’t the thrust been to boost spending via aggregate demand policies?
Here’s the smoking gun from the Bangko Sentral ng Pilipinas’ (BSP)[15] inflation report, which underscores the grand pirouette to a bubble economy in 2009[16]: (bold mine)
Maintaining an expansionary policy stance was seen to support market confidence and spending decisions of households and businesses as economic agents were reassured that risks to macro-stability were being addressed decisively…Given the lower-than-expected GDP growth of 0.4 percent for the first quarter of 2009, the decision to lower policy rates in May was aimed at providing additional boost to spending and investment in the economy and supporting market confidence in an environment of subdued price pressures.
Did you notice, for the BSP “lower policy rates” had been intended as “additional boost to spending”? By how? By promoting credit expansion which extrapolates to a frontloading of expenditures! Borrow today and spend! Boost statistical GDP! Borrow today and spend! Boost statistical GDP! Borrow today and spend! Boost statistical GDP!
Forget tomorrow. Forget balance sheet risks.
This real time application of quasi permanent boom policies represents the grand secret formula of the highly touted Philippine economic growth story.
Yet ironically when inflation becomes an issue the elixir vanishes!
When banks lend through money and deposit creation, these freshly minted money enters the economic stream is either spent or reallocated. So why won’t these “additional boost to spending and investment” not have an impact to prices of assets and goods?
What happens when the supply side fails to anticipate the additional demand generated by new money injections? A segment of the above quote from the taipan has been emblematic of this dilemma “The problem is there are no additional roads and infrastructure to absorb the increase”.
You see how inflationism can destabilize the economic coordination process through sharp fluctuations in price signals and by interrupting market expectations?
In the food spectrum, supply side severely underestimated demand. But in the asset markets, the supply side has massively been overestimating demand. The end result will be a huge gap or imbalance.
This also exhibits the “crowding effect” where the supply side has been overinvesting in asset markets while having to underinvest in agriculture.
Again by expanding credit, this translates to additional demand via fresh spending power that will be allocated or spent. And because of the abrupt surge in additional demand, the failure of the supply side to anticipate or expect demand changes prompts for a supply shock! Thus, prices rise!
It is the latter reaction that has been seen, read and peddled by the mainstream experts, politicians and bureaucrats to the public as THE cause.
Yet this represents a wonderful example of the cognitive bias called anchoring which reads past performance and extrapolating them into the future, here’s a quote from my favorite iconoclast thinker Nassim Taleb and Mark Blythe[17] (which I have previously excerpted)
As with a crumbling sand pile, it would be foolish to attribute the collapse of a fragile bridge to the last truck that crossed it, and even more foolish to try to predict in advance which truck might bring it down. The system is responsible, not the components
Logistics, hoarding and etc… signify as the last truck that crossed the collapse of the fragile bridge.
Here is what has been ignored by media: In reality, demand side pressures have been the PRIMARY source of current inflationary strains. Yet what have been mistakenly bruited as the source of inflation quagmire—the supply side—has merely been manifestations of the amplified impact of demand side pressures on the embedded constrains in supply side conditions.
Again the BSP’s policy directive: the decision to lower policy rates…was aimed at providing additional boost to spending and investment
So from: “Borrow today and spend! Boost statistical GDP!”
Now to: Deny the untoward effects of Borrow today and spend! Blame the moon and the stars for higher prices!
Thus the plausible deniability embraced by media and officials.
Another curiosity is the claim that “many more trucks for the delivery of goods and more cars because more consumers can afford them. This is a good thing”
To conclude that “more consumers can afford them” begs the question. Yet the tycoon, who echoes mainstream experts, doesn’t even bother to explain what drives consumers to afford more goods? Has productivity been rising significantly to raise real incomes? If so then why the price pressures? Obviously this isn’t what’s been happening.
Or has consumer demand been financed by credit? Or has the spending power by consumers emanated from industries that have massively leveraged their balance sheets?
Sadly, another round of earsplitting silence.
Beneficiaries of Inflationism Will Always Defend the Status Quo
But there is one thing true with the claim “This is a good thing” though.
The comment “This is a good thing” applies strictly to the interests of the billionaire magnate, whose core businesses has been rooted from political “concession rights”[18] from the Philippine government, which initially had been to operate a major container terminal in the Metropolis that eventually expanded throughout the nation. The publicly listed politically endowed cargo firm has reached a very dominant position to even attain quasi-monopoly status in several areas of operations and has even aggressively expanded overseas. The company has also gorged and feasted on BSP’s gift of low interest rates by racking up on debts.
And it’s definitely a good thing when one’s wealth skyrockets by nearly tripling; from US $1.6 billion in 2011 to US $ 4.5 billion in 2014 to attain 4th wealthiest person in the Philippines (based on Forbes Magazine’s measurements)!
And why wouldn’t current conditions be relishable or ‘a good thing’ for the taipan, when a lot of the gigantic wealth inflation has been propelled by a frenetic pump in the company’s equity prices which essentially ballooned the billionaire’s equity exposure in his firm to over Php 100 Billion as of March 2014[19] which now would be more than 10% higher. The taipan has even included a major casino in his portfolio.
Ironically such paper wealth inflation has been predicated on fantastic valuations on his flagship as seen by trailing PER of 30++ and PBV of 4++. All these, again, signify as another silver platter handout from the BSP.
Because the returns from savings relative to inflation has been negative due to suppressed interest rates, when the public bids up on his stocks in order to chase returns, then it would even be more of a good thing because not only will his wealth expand through more equity inflation, but the risks from overvaluation will partly be shouldered by the hapless public bearing the ‘old maid’ card. This applies to bond and other secured credit financers too.
Let me add that in free markets, rewarding company owners with higher equity values based solely on performance would not signify a moral deprivation. But when such rewarding mechanism has been skewed or disfigured by social policies as part of grand redistribution scheme then such would represent the moral decadence.
As a side note, take for instance the US equity markets where the Dow Jones Industrials just set new fresh record highs at over 17,000 last week. Who benefits from these? Writes the CNBC[20] (bold mine): “But the biggest beneficiaries are the top 10 percent of Americans who own some 80 percent of the stocks. And within that group, the largest windfalls have gone to corporate founders or big shareholders of certain stocks—especially in tech and energy.”
Roughly the same dynamics are being played out in the US, the Philippines and elsewhere
A news banner even screeched of the developing parallel universe or increasing disconnect between stock markets and the real economy in the US; this from Marketwatch.com “Dow Flirts with 17, 000…Why you are still poor as the market hits record highs”. Such report has been indicative of the public’s insouciance to record breaking stocks.
And the ongoing stock market pump based on the interest rate-yield curve manipulations has partly even been recognized by no less than the FED chair Janet Yellen who in a recent lecture before the IMF noted[21] (bold mine): A review of the empirical evidence suggests that the level of interest rates does influence house prices, leverage, and maturity transformation, but it is also clear that a tighter monetary policy would have been a very blunt tool: Substantially mitigating the emerging financial vulnerabilities through higher interest rates would have had sizable adverse effects in terms of higher unemployment.
Differently said, I admit there is a problem of alcoholism. But don’t take the alcohol away from the alcoholic, because the withdrawal syndrome would be catastrophic!
But it also is barely a good thing for the average Peso holders who agonizingly endure sustained losses in purchasing power from an invisible wealth transfer mechanism channeled through financial repression policies of negative real rates whose principal beneficiaries have been the patron-client political entities in the context of the government and their favorite economic agents.
Of course, who would want to ruffle the mainstream’s ‘good thing’?
Unfortunately economic reality has begun to reassert itself that will upend the establishment’s ‘this is a good thing’ meme via higher prices in economic goods.
Well this explains media’s tactical bait and switch approach, whose recourse has been to apply “appeal to authority” from a major beneficiary of today’s policies, blame everyone else markets greed and etc…, aggrandize the quack solutions of populist politics, while at the same time blatantly skirting to address the causal link involving credit, money and prices in the shadows of politics.
In the world of politics, economics has been portrayed to exist in a vacuum.
Philippine Banking Loans Explode Higher as Liquidity Drops!
I have been saying that the aside from chronic addiction to the stimulus from financial repression policies of negative real rates, the BSP has been boxed into a corner.
For the establishment, debt has been seen and peddled to the public as just a statistic premised on an extension of economic growth.
They hardly comprehend that aside from the resource aspect from debt acquisition or where debt was spent or used, debt can evolve from a mere compliment to outright dependency.
Under the latter phase, debt drives growth rather than debt as a compliment to growth.
I converted the Rahn curve—which reveals of the trade-off between economic growth and size of the government developed by economist Richard Rahn—into a possible diminishing return on debt (credit intensity) curve which exhibits the tradeoff between debt and growth. My point is to show the transition from optimum levels where debt compliments growth to debt dependency engendering low growth or recession risks.
For me boxed into a corner means[22]: Tighten money supply, credit shrinks and so will the economic sectors who breathes in the oxygen of credit that has played a vital role in the sprucing up of the pantomime of the pseudo economic growth boom.
Tolerate more negative real rates, debt accumulation intensifies, price inflation will rise, the peso will fall and such credit inflation will be reflected on interest rates, where the outcome will be market based tightening regardless of the actions of authorities.
The Bangko Sentral ng Pilipinas just released their banking loan data for May[23] 2014.
May’s data should reflect on the impact from the first reserve requirement[24] which became effective April 4th. Yet the BSP’s tally of the banking system’s loan growth which grew by 19% continues to dazzle! This would mark the highest rate of growth in 17 months (left window)!
In two months or in April-May there has been hardly any reprieve in the domestic banking system’s credit expansion.
I wonder, whatever happened to the supposed $2.7 billion siphoning of liquidity by the BSP?
Additionally this gives more evidence that the BSP may have pulled a rabbit out of the hat trick or a policy ruse on the public by using reserve requirements tool to show that they are acting to address financial stability risks, when in reality under the modern banking system reserves are now supplied by central banks[25].
Did you notice of the seemingly implacable pace of banking sector’s loan growth? This comes at more than twice the statistical economic growth rate where the latter has been in a decline for 3 successive quarters. (right window)
The implication is that credit-to-GDP levels should exhibit a very significant increase.
In a speech last year, the BSP chief cited the credit to GDP at 50.4% as of Q4 2012[26]. Allow me a back of the envelop calculation using current data to establish 2013 debt levels.
The average BSP’s measure of the banking system loan growth in 2013 has been at 13.5%. The average annualized growth per quarter in 2012 has been at 7.225%. So this implies a credit-to-gdp ratio now at around 56.7%.
Such level outstrips the 1984 high at 51.59%. This is the same period or in particular in 1983, where the Philippines faced a balance of payment crisis and an eventual inflationary recession in 1984[27] which I previously discussed here[28], chart from Wikipedia.org. Notice high inflation, high interest rates (T-bills). Rings a bell? (I know the bulls will assert we can’t have a balance of payment crisis because of foreign reserves! But shouting foreign reserves! foreign reserves! foreign reserves! are not free passes to bubbles)
Current credit-to-gdp levels have also surpassed the 1996 high at 54.85% and have been just shy away from the 1996 high of 62.22% in 1997. If the pace of current credit growth is sustained through the year at current economic growth levels, the 1997 acme will be easily reached or exceeded by the yearend.
At any rate, the Philippines economy has now reached critical levels—where if the past will rhyme—points to severe economic turbulence ahead.
As I wrote last year[29], While I expect the mania may go on through the year, anytime the Philippines reaches or even surpasses the 1997 debt levels then she will become increasingly fragile or vulnerable to a recession or a crisis that may be triggered internally or externally.
Will this time be different????
And we shall see the effects of the second reserve requirement which became effective in May 30, 2014[30], as well as the Special Deposit Account (SDA) 25 basis points hike which has been “implementable immediately” in the June data.
Let us dwell into the details of May’s banking loan report.
Banking loans to the utilities or Electricity gas and water sectors has likewise accelerated growing by over 35% (left window). Manufacturing loans has also been strong.
Loans to the bubble sectors (right window) continue to rage with financials and trade picking up tempo. Meanwhile real estate, construction and hotel have partly slowed. Notice that loans to bubble sectors have been 19% and above and still constitutes half of the banking system’s total lending at 50.08% in May but slightly off from 50.31% last March.
All these massive acceleration in loans won’t translate to credit risks in the face of rising inflation?
Additionally such intensive amount of credit, deposit and money growth has interestingly hardly been parlayed into liquidity growth.
In May, official data on money supply growth rates continues to fall which grew by just 28.4%[31] year on year. This represents a break below the fantastic 30% threshold levels seen during the previous 10 months. This looks consistent with my earlier projections where I see money supply growth rate to slump “to anywhere 20-25% (perhaps 22%) and will continue to fall!”[32]
It’s been a curiosity, where has all these fabulous sustained growth in money creation generated through the banking system been channeled to, if they are not circulating in the economy anymore? Has borrowing to generate growth—or diminishing returns of debt (credit intensity)—reached its natural limits? Are borrowings being made today in order to pay back existing debt? Has debt IN debt OUT become the new normal?
And if true, then this means that the illusory ‘boom’ effects from the aggregate demand policies may have started to reverse.
While the slowing liquidity would be theoretically good for currency holders as the pressures from price inflation should eventually ease, this would mean bad news for asset speculators and the asset inflation based growth model which the statistical economy has been pillared on.
With more borrowings channeled through debt payments, such increases debt burdens, reduce the incentive to expand thereby not only exerting pressure on profit margins but will curb demand as well.
And it will be a double whammy. Since money injection impacts the economy with a time lag, the earlier torrent of30+%% money injections will still exercise price pressures on the economy. So inflation risk will remain amidst emergent debt deflationary pressures on the financial system.
Malinvestments that grew at the back of money supply growth will be exposed for what it truly is: a Potemkin Village brought about by the money illusion.
BIS to BSP: Raise Interest Rates!; On the 6,900 Phisix Breakout
The BSP remains under political and administrative pressure.
The BSP chief was surprisingly quoted as saying that interest rates are subject to rise because of financial risks.
Here is the shocking quote (bold mine): While underlying economic conditions remain mostly supportive for growth, financial market conditions still pose risks that could weigh on the performance of emerging markets like the Philippines, Bangko Sentral ng Pilipinas (BSP) Governor Amando M. Tetangco Jr. said. “There’s still a need to improve and establish a more enduring growth trajectory in the real economies,” Tetangco told reporters Tuesday evening[33].”
Huh? Financial market risk, where? The US, China, Japan, Europe…or anywhere except the Philippines??? He doesn’t specify Why?
Hasn’t it been that the BSP’s instituted aggregate demand policies should have reduced dependence from exogenous forces? Again the BSP chief in 2009 “must boost domestic consumption and end its dependence on exports” via “counter-cyclical support to aggregate demand in the form of expansionary fiscal and monetary policies, along with strong policy actions to ensure financial and corporate sector health could contribute to faster recovery.[34]” Then what’s the worry?
But we have a magical growth model, so why worry?
Will capital outflows be the trigger to expose on who has been swimming naked when the inflation tide runs out? Has this been his concern? So what happened to “transformational”?
It’s also in this report where I predicted of the coming price controls “Nonetheless given the propensity to attack the symptoms, it is not farfetched that the Executive Branch will join the BSP to impose populist ‘price control’ measures.”
Yet what enduring growth trajectory?? More central bank pump and the eventual dump? More economic growth based on debt financed asset inflation???
The nice part about political rhetoric has always been the ambiguity that shrouds them. Officials look good with motherhood statements without saying specifics.
The BSP appears to be under strain from the Bank of International Settlements (BIS), the central bank of central bank or an institution which the Inquirer describes as sets the “policies that all monetary regulators must follow”.
And here is the Aha Moment (!) where the BIS appear to have the placed the BSP under tension: “The advice of some of the participants was that central banks should start raising interest rates,” Tetangco said.
Independent central bankers eh? uh uh
The BIS pressure has been applied not only on the BSP but to all other central banks
Sounding like Austrian economists, the BIS has implicitly denounced aggregate demand policies[35], The Bank for International Settlements has warned that “euphoric” financial markets have become detached from the reality of a lingering post-crisis malaise, as it called for governments to ditch policies that risk stoking unsustainable asset booms.
See, even the central bank of central banks sees what I have been saying all along!
Let us read it straight from the Bank of International Settlements[36] (bold italics mine)
The global economy is struggling to step out of the shadow of the Great Financial Crisis. The legacy of the crisis is pervasive. It is evident in the comparatively high levels of unemployment in crisis-hit economies, even as output growth has regained strength, in the disconnect between extraordinarily buoyant financial markets and weak investment, in the growing dependence of financial markets on central banks, in rising private and public debt, and in the rapidly narrowing policy room for manoeuvre…These adjustments should acknowledge that the post-crisis balance sheet recession is less amenable to traditional aggregate demand policies and puts a premium on balance sheet repair and structural reforms, that financial booms and busts have become a major threat to macroeconomic stability, and that the only source of lasting prosperity is a stronger supply side, notably higher productivity growth…There is a need to rely relatively less on traditional aggregate demand stimulus and more on balance sheet repair and structural reforms, especially in crisis-hit economies. Monetary policy, in particular, has been overburdened for too long. After so many years of an exceptional monetary expansion, the risk of normalising too slowly and too late deserves special attention.In countries experiencing strong financial booms, the priority is to strengthen defences to face a potential bust. There, too, structural reforms should not be delayed. In the longer term, the main task is to adjust policy frameworks so as to make growth less debt-dependent and to tame the destructive power of the financial cycle. More symmetrical macroeconomic and prudential policies over that cycle would avoid a persistent easing bias that, over time, can entrench instability and exhaust the policy room for manoeuvre. The risks of failing to act should not be underestimated. The global economy may be set on an unsustainable path. And at some point, the current open global trade and financial order could be seriously threatened.
My humble two cents:
Balance sheet disorders have been a consequence of previous aggregate demand policies. Policies to resolve balance sheet problems with more of the same aggregate demand policies, as evident in advanced economies, results to what the BIS calls as the financial cycles (euphemism for bubble cycles).
The Philippines, for instance, has hardly any balance sheet malady during the Great Financial Crisis of 2008, but because of the grand pivot or the imposition of aggregate demand policies in 2009, balance sheet risks have reared its ugly head to become main source of financial instability—expressed not only through soaring debt levels but to massive mispricing of assets and misallocation of resources based on the popular delusion premised on unproductive linear growth trajectory of consumers.
Next, despite any real reforms the next crisis is inevitable. And this would most likely be even greater than the Great Financial Crisis of 2008, for the same reason: colossal imbalances that have been built on the back of current aggregate demand policies. And the reason it will be greater is that almost every economy has embraced these policies, so bubble popping won’t just be in one or two economies but in many major advanced and developing economies, including ASEAN and the Philippines.
The BIS chides the central banks for short term policies.
As history reminds us, there is little appetite for taking the long-term view. Few are ready to curb financial booms that make everyone feel illusively richer. Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms. Or to address balance sheet problems head-on during a bust when seemingly easier policies are on offer. The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end. The road ahead may be a long one. All the more reason, then, to start the journey sooner rather than later
Hallelujah on this. But with the exception of “financial booms that make everyone feel illusively richer”. The only persons who feel illusively richer are the asset holders or mainly the elite.
My impression is that the BSP will DEFY the BIS. I may be wrong but they will hardly raise rates directly but use all other side ‘macroprudential’ tools (SDA rates, reserve requirements) as decoy to show that they are doing something. But the BSP will likely push inflationism to its limits, as just shown above, until the real economy cracks.
Final note: Oh, bulls widely cheer on the low volume 6,900 breakout by the Phisix amidst intensifying inflation pressures and slowing economic growth.
Don’t you see wonderful times are back again?
Yet for the last two major tops 1994-1997 (upper) and 2007-2008 (lower), history tells us that following bear market strikes, the Phisix rallies back to the old highs but traps the bulls into a deflationary chasm after.
Will this time be different????
I end this outlook with the magnificent quote from Emrys Partners Hedge, a hedge fund which just shut down and where the quote has been part of the firm’s regulatory filing last May[37].
making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy…While individual company analysis will always be important, the health, or the change in the health, of the financial system is the starting point of all analysis
This comment represents the zeitgeist of the current bubble times.
[2] Inquirer.net Price rise traced to logistics gridlock June 30, 2014
[3] See Phisix: BSP’s Response to Peso Meltdown: Raise Banking Reserve Requirements March 31, 2014
[4] Inquirer.net Senators ask why the price of garlic goes up, up, away, July 4, 2014
[5] Inquirer.net President urged to control prices July 5, 2014
[6] See Phisix: 30+% Money Supply Growth Rate Now Seen in Official CPI Data June 9, 2014
[7] Department of Trade and Industry The Price Act of July 1992 REPUBLIC ACT NO. 7581 AN ACT PROVIDING PROTECTION TO CONSUMERS BY STABILIZING THE PRICES OF BASIC NECESSITIES AND PRIME COMMODITIES AND BY PRESCRIBING MEASURES AGAINST UNDUE PRICE INCREASES DURING EMERGENCY SITUATIONS AND LIKE OCCASIONS…Price ACT…1. DEPARTMENT OF AGRICULTURE (A) Basic Necessities • rice • corn • cooking oil • fresh, dried fish and other marine products • fresh eggs • fresh pork, beef and poultry meat • fresh milk • fresh vegetables • root crops • sugar
[8] Ludwig von Mises 4. How Price Control Leads to Socialism Middle-of-the-Road Policy Leads to Socialism Mises.org
[9] Loc cit June 9, 2014
[10] See Phisix: Understanding the Dynamics Behind ‘Pump and Dump’ June 29, 2014
[11] Bangko Sentral ng Pilipinas Inflation Edges Lower to 4.4 Percent in June July 4, 2014
[12] See Street Talk: Reactions of Philippine Residents to the current surge in consumer price Inflation rates June 17, 2014
[13] See Daddy’s Day [Abridged] Edition: Phisix: The Climaxing Philippine Property Bubble! June 15, 2014
[14] See Phisix: Why Tomorrow’s Fundamentals will be Distinct from Yesterday, March 3, 2014
[15] Bangko Sentral ng Pilipinas Second Quarter 2009, Inflation Report, p .42
[16] See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014
[17] Nassim Nicolas Taleb and Mark Blythe The Black Swan of Cairo May/ June 2011 Foreign Affairs
[18] International Container Terminal Services Annual Report 2013 p.55
[19] Manila Times Razon’s ICTSI holdings breach P100B March 11, 2014
[20] Robert Frank The rally rich: Who gained the most from stocks July 2, CNBC.com
[21] Janet L Yellen: Monetary policy and financial stability Text of the 2014 Michel Camdessus Central Banking Lecture by Ms Janet L Yellen, Chair of the Board of Governors of the Federal Reserve System, International Monetary Fund, Washington DC, 2 July 2014. Bank of International Settlements
[22] See Phisix Melts Up as Money Supply Growth Sizzles for the Eight Month April 7, 2014
[23] Bangko Sentral ng Pilipinas Bank Lending Continues to Grow in May June 30, 2014
[24] See Phisix: BSP’s Response to Peso Meltdown: Raise Banking Reserve Requirements March 31, 2014
[25] See Showbiz S&P Upgrade & BSP Actions Sends Phisix and the Peso into a Frenzied Blow off Top May 12, 2014
[26] Amando M Tetangco, Jr: The Philippine economy – primes for a sustainable and solid growth March 12, 2014
[27] Philippine Institute of Development(PIDS) THE BALANCE OF PAYMENTS CRISIS AND THE ECONOMY March April 1985
[28] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2014
[29] See Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013
[30] Bangko Sentral ng Pilipinas Monetary Board Maintains Policy Rates, Adjusts Reserve Requirements May 8, 2014
[31] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Eases Further in May June 30, 2014
[32] See Phisix: Watch Out, Money Supply Growth Will Fall Sharply by July! May 25, 2014
[33] Inquirer.net Interest rates on the way up, says BSP July 3, 2014
[34] See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014
[35] Financial Times ‘Euphoric’ capital markets are out of step with reality, warns BIS June 29, 2014
[36] Bank of International Settlement 84th Annual Report 1 April 2013–31 March 2014, p 20
[37] Wall Street Journal Emrys Partners Hedge Fund Shuts Down July 3, 2014
