Central banks have tried to create inflation at any cost under the misguided view that this will boost growth and help reduce the debt burden. Just as a pilot driving a Ferrari with the instructions of a Ford T, central banks are pushing the accelerator looking at the rearview mirror and screaming “go faster, we have not crashed yet!”—Daniel Lacalle
In this issue
A Big Economic Comeback in 2021? Or Will Stagflation Risks Upset Consensus Expectations?
I. A Big Economic Comeback in 2021? Or Will the Business Cycle Play a Bigger Role?
II. Stagflation Risks Redux: December CPI Reinforces Uptrend
III. Stagflation Risks from Financial Repression or the Inflation Tax
IV. Stagflation Risks from the Boom-Bust Cycle; Philippine Yield Curve Sees More Inflation
V. Post Script: With Elections in 2022, Will the Quarantine Be Used to Extend the Incumbent’s Power?
A Big Economic Comeback in 2021? Or Will Stagflation Risks Upset Consensus Expectations?
I. A Big Economic Comeback in 2021? Or Will the Business Cycle Play a Bigger Role?
Corporate earnings, manifesting economic conditions, are about to stage a strong comeback in 2021. That’s the unanimous verdict of the establishment consensus. Unfortunately, such forecasts come from the same clique that has failed to see the record recession of 2020.
According to Wikipedia, recessions signify a business cycle contraction when there is a general decline in economic activity.
But a general decline in business activity is unlikely to occur without a centralizing force influencing them.
In a market economy, many businesses are born and perish each day. Unproductive assets, representing businesses unable to satisfy the consumers viably, are liquidated and or taken over by new entrepreneurs. Its decentralized mechanism—consisting of millions of moving parts coordinating, allocating, and clearing the marketplace spontaneously and thus prevents the accrual of imbalances—reduces the general business fluctuations.
Today’s recession is a product of a politically mandated economic shutdown purportedly in response to the pandemic. The lockdown induced recession represented a supply and demand shock, which forced income, wage, and job losses, as well as massive disruptions on production, distribution, and exchanges. More importantly, the shutdown caused capital decumulation and exacerbated accrued imbalances from the pre-pandemic era.
And what is the supposed blueprint for the 2021 growth?
The implementation of a mishmash of top-down measures consisting of infrastructure spending, the vaccine rollout, the accelerated reopening of the economy, the CREATE bill, credit easing, and other proposed public spending and relief programs of the National Government and the BSP should serve as the antidote to the record recession of 2020.
The point is, while top-down policies caused the record recession, the establishment sees the economic comeback predicated on the same failed centralized planning activities.
Figure 1
The mainstream seems to see the economy in the perspective of Milton Friedman’s plucking theory, which analogizes the economy like a string on a musical instrument. While recessions pull the string down, an economic recovery translates to a snapback of the string to its normal or original trajectory. (Figure 1, topmost window)
Hence, to fill the (growth) vacuum created by the recession, the BSP-National Government implemented myriad rescue measures (mostly throwing of money).
Such policies, however, has been seen by the establishment as having only beneficial effects. Its costs have been ignored or discounted. That is, for the consensus, market and economic interventions by political authorities signify free lunches.
But contrary to the consensus, 2021 will likely see the intertemporal impact of the gobs of policies that prevented the markets from clearing or adjusting naturally to reflect the new political-economic conditions.
Or, in 2021, the economy will reflect on the intertemporal consequences of closing the economy, such as the massive dislocation of the supply networks, the capital decumulation, the unintended ramifications of the unprecedented expansion of the balance sheet of the BSP, the record low rates and liquidity conditions, surging public and private debt levels, historic fiscal deficits, and many other interventions.
And such potpourri of interventions should exacerbate the imbalances of the existing economic maladjustments before the pandemic, and thus, should aggravate the unintended economic and financial ramifications from the entwined feedback loops.
The effects of the business cycle will also be a factor in 2021.
The late great Austrian economist and Professor Hans Senholz described the primary causal factor of the Great Depression, which should be relevant today.
Inflation and credit expansion always precipitate business maladjustments and malinvestments that must later be liquidated. The expansion artificially reduces and thus falsifies interest rates, and thereby misguides businessmen in their investment decisions. In the belief that declining rates indicate growing supplies of capital savings, they embark upon new production projects. The creation of money gives rise to an economic boom. It causes prices to rise, especially prices of capital goods used for business expansion. But these prices constitute business costs. They soar until business is no longer profitable, at which time the decline begins. In order to prolong the boom, the monetary authorities may continue to inject new money until finally frightened by the prospects of a runaway inflation. The boom that was built on the quicksand of inflation then comes to a sudden end.
The ensuing recession is a period of repair and readjustment. Prices and costs adjust anew to consumer choices and preferences.
Hans F. Sennholz The Great Depression, Mises.org December 11, 2020
Furthermore, the writing was on the wall for a recession of 2020.
From my February 2020 outlook
From the financial side, do you remember that 2019 opened with the Hanjin Heavy Industry’s debt default in January? Although this event was downplayed by the BSP and the banking system, it certainly contributed to the siphoning of the financial liquidity that the led to the inversion of the yield curve, and subsequently, the aggressive response of paring down 400 bps of RRR requirements in favor of banks, the 75 bps policy rate cuts and the BSP’s record QE.
From the real economy side, do you recall the emergence of the NCR’s water crisis and the power shortages in the first semester last year?
How about the deluge of national health issues, such as the spike in the dengue cases, which led the National Government to declare the “national dengue epidemic”, the polio outbreak, the HIV outbreak, the measles, and the African Swine Fever (AFS) outbreak?
While some concerns, such as water, and power shortage, may have subsided, the year of the RAT continues to carryover dengue (though at diminishing rate), polio, HIV, measles, and AFS.
The Coronavirus Pandemic: Who is Panicking? More From the Year of the Rat: Will History Rhyme? February 2, 2020
Add to the above, in the 1Q of 2019, the Philippine yield curve inverted to signal intensifying tightening conditions in the banking system. Furthermore, even in the perspective of the GDP, while climaxing in 2016, household consumption has been on a downtrend and increasingly supported by consumer credit than by the productivity gains. (Figure 1, middle and lowest pane)
Outside the bailout measures by the BSP that should bring about palliative effects, what dynamics have changed to support a structural reversal of these adverse factors?
II. Stagflation Risks Redux: December CPI Reinforces Uptrend
As discussed last December, predicated on five factors, stagflation risk will dominate the economic landscape in 2021.
One, momentum and trend.
Two, the massive disruption of the division of labor and Say’s Law.
Three, the BSP’s inflation tax.
Four, the BSP’s recent policy of inflating asset bubbles
Last, the domestic yield curve has been signaling higher inflation.
Five Reasons Why Stagflation Risks Will Dominate the Economic Landscape in 2021 December 7 2020
This outlook presents the latest update.
One, momentum and trend.
From the Inquirer (January 6): The pace of price increases for basic goods and services in the country will likely remain within forecasts over the foreseeable future, as confirmed by the latest data, according to the central bank. In a statement, Bangko Sentral ng Pilipinas (BSP) Governor Benjamin Diokno said the December 2020 inflation of 3.5 percent was within the monetary regulator’s forecast range of 2.9-3.7 percent….Diokno said the recent uptrend in inflation was seen to be “largely transitory” reflecting the short-term impact of weather disturbances.
Nota bene: This author does not believe in the accuracy of the CPI simply because averaging different goods as potatoes, cars, laptops, and Netflix subscription fees represent a ridiculous and impractical exercise, and thus, do not reflect a realistic demonstration of price changes experienced by individuals writ large (community). Furthermore, since the CPI is a political-economic sensitive number, as per the PSA, “it is a major statistical series used for economic analysis and as a monitoring indicator of government economic policy”, hence to advance the political-economic agenda of the incumbent such statistics are vulnerable to interventions. But anyway, using the lens of the mainstream, we extrapolate this data alongside the others to arrive at some clues of the political economy heading forward.
I believe the BSP understates the actual conditions.
Figure 2
The National Government’s (NG) primary measure of statistical inflation, the CPI, has been on an uptrend since its recent trough last September 2019 or before the pandemic. It broke above the January 2020 highs last November and accelerated further this December. (Figure 2, upmost window)
And while international oil prices have been surging, the Transport CPI has rising faster to reflect on domestic factors. (Figure 2, middle pane)
Strikingly, even the CORE CPI appears to be testing the previous two highs of 2020 for a possible breakout.
Two, the massive disruption of the division of labor and Say’s Law.
No better example than excerpts extracted from the mainstream news.
From the Businessworld (January 8, 2021) DA Assistant Secretary Kristine Y. Evangelista said in a Laging Handa briefing Friday that the retail price of pork has also risen because some growers shut down operations in the early stages of the pandemic and have not reopened since. The ASF outbreak was first detected in provinces around Metro Manila in 2019.
From ABS-CBN News (January 7, 2021): Pork prices continue to rise as African swine fever (ASF) decimates hog populations across Luzon, while chicken prices have also gone up as supplies dwindled with many poultry farms having gone bankrupt last year.
Supply dislocations brought about by the lockdown policy had been exacerbated by the recent typhoons in the 4Q of 2020 and by the Asian Swine Flu.
In the meantime, the overseas option for the supply side…
From the UN’s Food and Agriculture Organization or FAO (January 7 2021): World food prices rose for the seventh consecutive month in December, led by dairy products and vegetable oils, the Food and Agriculture Organization of the United Nations reported today. The FAO Food Price Index averaged 107.5 points in December, 2.2 percent higher than in November. Over the whole of 2020, the benchmark index, which tracks monthly changes in the international prices of commonly-traded food commodities, averaged 97.9 points, a three-year high and a 3.1 percent increase from 2019 although still more than 25 percent below its historical 2011 peak. (Figure 3 middle and lowest pane)
Manifesting the escalation of demand-supply imbalances worldwide, continuing pressures on global food prices should narrow the sources for alternatives while simultaneously amplifying domestic inflation risks.
And Food CPI components have the largest aggregate weight in the NG’s CPI basket of 35.6%. Thereby, expanded price volatility in it would amplify the rate of change of the headline index.
And it is not just food prices…
From the Financial Times (January 8, 2021) The world’s largest carmakers are facing a potentially crippling shortage of semiconductors, as chipmakers reserve supply for tech groups producing smartphones, tablets and gaming devices…The rapid growth of the electric-car market has increased the motor industry’s demand for semiconductors, which power everything from battery management, to driver assistance systems and in-car entertainment. “After the industry shutdown in the early phase of the crisis and the resulting abrupt drop in demand, automobile manufacturers across all regions increased their production volumes much faster than expected by market experts,” Continental said, which resulted in a rush on semiconductors. ..According to industry insiders, some carmakers could see production reduced by 10-20 per cent a week from February if fears over shortages are realised. “The problem is that we are lower down the chain than companies like Apple and HP,” said one executive. “The auto sector doesn’t pay as much for its semiconductors.” Ola Kallenius, Daimler chief executive, said the whole chip production industry “was thrown into a little bit of a flux” in 2020, and that was “affecting many or most [manufacturers’] in some shape or form”.
That’s Say’s Law or the Law of markets in motion.
III. Stagflation Risks from Financial Repression or the Inflation Tax
Three, the BSP’s inflation tax.
But here is the thing, the higher inflation has been an implicit goal of the BSP, especially under current conditions.
From the Philstar (January 5): Faster inflation for the past 3 months is not convincing the Bangko Sentral ng Pilipinas (BSP) to reverse course from last year’s aggressive monetary easing that brought record amounts of liquidity to the financial system but risks stoking prices. “We intend to keep this accommodative monetary policy for long. So interest rates, I think, will be around this level which is around 2% for many quarters to come,” BSP Governor Benjamin Diokno said in an interview with ABS-CBN News Channel.
Figure 3
The BSP insists on maintaining low rates to subsidize the rapidly expanding public debt. Negative real rates represented by higher CPI over interest rates (shown by the ON RRP or the BSP’s policy) serve as an inflation tax, an invisible way to finance borrowers, such as the record public debt. It is a form of Financial Repression or redistribution of finances from the saving public to the government. (Figure 2 lowest window)
With public debt reaching a stratospheric Php 10.134 trillion or 51.9% of the 2019 ANNUAL GDP, as of November, inflating such debt away seems to be the preferred political option than raising taxes with national elections on the horizon. (Figure 3 upmost pane)
Also, the CREATE bill, once enacted, is likely going to blow the fiscal deficit wide open, requiring even more public funding.
Because the exploding growth of debt means HIGHER taxes over time, which is likely to transpire after the elections, this tax reform bill represents another smoke and mirror policy. Administration officials are already exploring the preposterous option of imposing a wealth tax. Incredible.
From the Inquirer (January 9): For Albay Rep. Joey Salceda, who chairs the House ways and means committee from which tax measures emanate, “the principle of taxing wealth is elegant and sound.” “We have to penalize hoarding wealth and not making it useful for national development. I have always said that our largest state failure is our failure to tax the rich,” Salceda told the Inquirer.
Should a wealth tax be implemented, not only will the Philippines be swerving to the hard left, but the country is bound to see the decimation of capital and the consequences that go along with it.
Moreover, public borrowing operations are not solely to finance deficits but are likewise intended to boost the supply of treasury securities required by the BSP for its balance sheet expansion to rescue the banking system.
And though it is politically convenient for the NG-BSP to attribute supply issues as the foundation of the spate of increases in inflation, a slight pickup in demand should be enough to magnify the distortions in the supply network that risks escalating the rate of price increases. As previously noted, in the context of the mainstream’s hope for a robust recovery, “be careful what you wish for”.
Of course, the NG’s mechanical reaction to price hikes would be to impose controls that should further intensify economic imbalances over time.
IV. Stagflation Risks from the Boom-Bust Cycle; Philippine Yield Curve Sees More Inflation
Four, the BSP’s recent policy of inflating asset bubbles.
Figure 4
To goose up market confidence that ensures the National Government’s access to cheap savings, as well as to keep bank collateral values from deflating, the BSP’s record Php 2 trillion liquidity injections have been instrumental in boosting prices of financial assets, including the stock market, the spillover effect of which is likely to reflect a higher CPI.
Rising stocks have been associated with climbing CPI—until the latter reaches a breaking point. (Figure 4, top window)
The banking system's balance sheet is being kept afloat not just from the BSP's torrential cash injections, borrowings from the capital markets, and regulatory relief measures, but importantly, intensifying speculations on the capital markets. (Figure 4, middle window)
That said, on the demand side, while the banking system’s core operations of lending have entered the deflationary domain contracting by .16% last November, the first in at least a decade, which translates to feeble aggregate domestic demand, the BSP’s record injection via QE has clearly been the primary contributor to the money supply growth.
Trends of the CPI and bank lending, which formerly drifted in unison, has gone in the opposite directions. (Figure 4, lowest pane)
That is, select beneficiaries from the BSP’s monetary injections have enjoyed increased demand notably the bureaucracy, the bank/financial industry and the listed member firms of the PSE in the face of a struggling, grinding economy.
The K-economy.
On the supply side, dislocations from the economic shutdown aggravated by the exogenous forces as natural calamities, global oil prices, the Asian Swine Flu, and others, aggravated by price controls, have induced a supply shock.
Hence, to ward off bank credit deflation by supporting asset markets, the BSP has opted for the extension of the inflation tax under the pretext of providing financing to the National Government.
From the CNN (January 6): The Bangko Sentral ng Pilipinas has granted a third zero-interest loan to the national government worth ₱540 billion to boost available funds for COVID-19 response. BSP Governor Benjamin Diokno said Wednesday that the central bank's Monetary Board approved last December 28 the grant of another credit line to the Bureau of the Treasury. It is effectively a renewal of sorts, as the state earlier borrowed a similar amount in September which fell due last month.
Aside from higher street prices, with sin taxes, welfare contributions (SSS, and Philhealth) slated to go up this year, how are these supposed to boost consumer spending?
Further, how much increases in inflation and interest rates can this highly leveraged economy afford?
As stated last December, the unwinding of bubbles will contribute to the general tightening of money that should add to the pressure of increasing rates.
Last, the domestic yield curve continues to signal higher inflation.
Figure 5
Yield pressures are likely to ease from the liquidity extension of the BSP's 1st QE of 2021 in early 1Q.
However, the steepening BVAL curve trend, which has its roots since 1Q 2019, should most likely continue, given the enumerated factors above.
Moreover, considering the close correlation of the yield trends of US Treasuries and the domestic treasuries, 10-year UST yields, which spiked last week, are likely to pull up their domestic counterparts.
It looks likely the twilight for the days of easy money.
And while I share a big hope for a more positive 2021, economics tells us that the effects of the credit financed asset bubbles punctured by the pandemic will become more evident as the year ages.
And given the complexity of current events, little of what the mainstream expects is about to come to fruition.
V. Post Script: With Elections in 2022, Will the Quarantine Be Used to Extend the Incumbent’s Power?
And one more thing.
From the Philstar (December 4, 2020): The Philippines is expected to remain under a prolonged quarantine next year, with restrictions seen to be removed only in 2022, according to the National Economic and Development Authority (NEDA).
From the Inquirer (September 18, 2020): President Rodrigo Duterte has extended the state of calamity placed over the entire Philippines for one more year due to the COVID-19 pandemic. In his Proclamation No. 1021, Duterte extended the state of calamity “for a period of one year, effective 13 September 2020 to 12 September 2021, unless earlier lifted or extended as circumstances may warrant.”
With elections in 2022, will the sitting President ease on the near absolute grip of political power? Or, will this opportunity be used to consolidate further gains on his political capital to extend tenure?
