Cross-posted at the Prudent Investor newsletter Blog
The obsession with the "price level" has done much harm to the conduct of monetary policy. Most modern central banks practice so-called inflation targeting without being fully aware that the inflation rate as their indicator is a chimera. By following this concept, central banks ignore that their guidepost is a phantom and additionally that the idea that the price level should rise steadily itself makes no economic sense. In the perspective of the monetary theory of the Austrian school, the consternation of the monetary policy makers in the face of their repeated failure is neither a surprise nor historically new. The official inflation rate misleads the central bankers as well as the financial market operators—Antony P Mueller
The Impact of Vote-Buying; the April CPI Breakout; The Structural Foundations of Inflation
I. The April CPI Breakout: Food CPI Spiked, Transport Industry Suffer from Sustained Real Income Losses
II. Income Squeeze: Household Resort to Credit Card Debt!
III. Growth or Stagflation? PPI-CPI Margin Squeeze, Inflation Psyche Hounds the Manufacturing Sector
IV. Demand Side Pressures from Higher Bank Lending; Financial Assets Under Pressure from Tightening Liquidity
V. The Relationship of Vote-Buying with Politicized Economic Distribution and Public Spending; The Seeds of Political Dynasty, Cronyism and Corruption
VI. The Influence of Publicly Financed Election Spending on the Economy
VII. The Money Supply Cycle of National Elections; Milestone Deficits and Debt!
VIII. Domestic Price Pressures from the Weakening Peso
IX. The Structural Foundations of Inflation: A Centrally Planned Government
The Impact of Vote-Buying; the April CPI Breakout; The Structural Foundations of Inflation
The April CPI raced to 2019 highs.
While the mainstream casts surging oil prices as the primary culprit, we try to explain below the many interdependent factors driving it.
Election spending, signifying part of the public outlays, represents one of them.
And vote-buying is one of the symptoms of politicized economic distribution and public spending.
Finally, while the consensus portrays high inflation as an anomaly, the thrust to centralize the economy underscored by the free money policies of the BSP provides structural support for its long-term rise.
Figure 1
I. The April CPI Breakout: Food CPI Spiked, Transport Industry Suffer from Sustained Real Income Losses
CNN, May 5: The Philippine Statistics Authority on Thursday reported an annual inflation rate of 4.9% for April, the fastest in more than three years, with food and energy costs leading the rise in prices. The recent pace, which is the quickest since 5.2% in December 2018, marks the first time that inflation breached the 2-4% target band of the Bangko Sentral ng Pilipinas for this year. April’s rate also brings average inflation for 2022 to 3.7%.
Authorities still provide a limited set of data on the CPI based on 2018 prices, which it has yet to expand to equip the public with a better perspective of the statistical inflation.
Why are authorities keeping the public in the dark?
From the current data set, the CPI of April 2022 accounted for the highest since 2019!
But the rebasing of the CPI translates to the omission of about .5 to .6% from the 2012 base or about 1% from the 2006 base. Or, the latest CPI could have reached 5.5% and 5.9%, respectively, had both been calculated from the previous bases.
Nevertheless, April CPI represents a BREAKOUT of the consolidation phase of the uptrend since 2019 or the longer-term trend starting from 2015.
Despite the ballyhooed boom from the reopening and the April breakout, the CPI remains repressed. The treasury markets say so.
Nevertheless, food CPI belatedly spiked, which pushed the CPI to its breakout level in April.
Because the mainstream attributes the rising CPI mainly to oil, we provide a perspective using this premise.
First, the correlation between oil prices and the Food CPI appeared to have broken in 2021 but may have started to recover. (Figure 1, upmost pane)
The boost in the food CPI had been also due to double-digit increases in corn, and Oil & fats, which jumped by 27.1% and 11.7%. Although the weightings of both items, .48% and .57% in the basket, render them negligible. Of course, it is not insignificant to consumers of these items who suffer from more lost purchasing power than the rest.
Demand for the other food items should increase once they opt to substitute, whereas the high-priced items should fall. That's the theory.
But the ramifications of credit financed demand in the face of supply constraints are likely to diffuse price pressures across the food product universe.
Raging oil prices are just part of the complex feedback loop altered by the disruption of the division of labor.
Next, the transport sector continues to bleed from surging energy prices. With price controls reducing the 'real' income of the industry, how can growth occur? (figure 1, middle window)
II. Income Squeeze: Household Resort to Credit Card Debt!
The households are also in the same boat.
With utility fees soaring, the household disposable income also shriveled. How will this enhance spending on a broader scale? (Figure 1, lowest window)
Figure 2
With the squeeze in real income by the rising CPI, households appear to be increasing their reliance on credit cards to supplement their consumption. Household credit card use expanded by 12.06% in March (YoY), from 8.06% a month ago, despite rising rates. (Figure 2, upper pane)
The increasing use of leverage seems anchored on expectations that the higher CPI and interest rates are 'transitory.'
The credit card from the universal and commercial banks reached Php 446 billion and is just off by .9% from its January 2020 record of Php 450 billion.
Nota bene: This author does not believe in the accuracy of the CPI simply because averaging different goods such as potatoes, cars, laptops, and Netflix subscription fees represent a ridiculous and impractical exercise, and thus, does 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.
III. Growth or Stagflation? PPI-CPI Margin Squeeze, Inflation Psyche Hounds the Manufacturing Sector
But how about the industry?
The difference between the PPI and CPI turned negative in the last three months through March. (Figure 2, lower pane) It points to a margin squeeze for wholesalers and retailers.
How will this translate to income and economic growth?
Further media sees anything rising as growth. They cannot seem to differentiate the effects of inflation on economic activities.
Here is the $&P Markit on the Philippine manufacturing conditions last April.
S&P Markit, May 22 (bold added): Output and new orders increased for the third month running in April, with the respective rates of growth both accelerating from March to the quickest since November 2018. Anecdotal evidence indicated that looser pandemic restrictions had supported the latest upturns in customer demand and production schedules. That said, demand from international markets decreased for the second month running. Russia’s invasion of Ukraine, higher shipping costs and limitations due to the pandemic had reportedly hampered new export orders. Concurrently, raw material shortages and transportation delays led to a further lengthening of average suppliers’ delivery times. That said, the extent to which lead times for inputs increased was the least severe for nearly two-and-half-years. The improvement in customer demand and rising production requirements led to a further increase in buying activity in April. Notably, the rate of growth was the fastest in more than three years. At the same time, firms increased their holdings of raw materials and semi-finished items. Furthermore, the rate of accumulation in stocks of inputs accelerated to one of that fastest seen since the survey began in January 2016. The level of work-in-hand (but not yet completed) declined again in April, and at a solid pace. A number of firms commented that rising production had helped them to process and complete orders. Meanwhile, April data pointed to a stabilisation of workforce numbers across the Filipino manufacturing sector. Improving economic activity resulted in no change in employment in the latest survey period, thereby ending a 25-month period of job shedding. However, reports of worker resignations were widespread, often due to the pandemic, which weighed on companies’ abilities to expand staff numbers overall.
What media misconstrues as 'growth' represents inflationary dynamics instead.
The accelerated demand experienced by producers is primarily due to supply scarcities, accentuated by the lengthening of delivery times.
For the same reason, producers have intensified their accumulation of input inventories at unprecedented rates.
But if producers foresee such expansion as sustainable, why haven’t they been hiring?
Yes, producers have ended the string of cutting jobs, but the workers are on exodus. So the workers have done the task of their employers.
Companies should be hiring on a massive scale under current conditions. But they have opted to store up on inventories instead.
The choice of inventories over personnel is a sign that firms are working to protect their margins against further input price surges.
In any case, demand for money has been falling materially relative to goods and services. That isn’t growth in the textbook sense.
Instead, it is a symptom of the entrenchment of the psychology of inflation. Or these are signs of the strengthening transition towards stagflation.
IV. Demand Side Pressures from Higher Bank Lending; Financial Assets Under Pressure from Tightening Liquidity
The April CPI was hardly about oil prices, material shortages, shipment delays, and supply bottlenecks.
A revival of bank lending activities signifies the demand component.
Figure 3
But increases in bank lending don’t necessarily imply growth unless used for investments.
In March, the biggest bank borrowers were the real estate, trade, and information and communications sectors. Universal and Commercial banks saw their portfolio increase by 8.9% (YoY) (Figure 3, upper pane)
Are these industries raising money for liquidity purposes than expansion?
As noted above, consumer lending grew too. It was up by 3.62% in March, primarily due to credit card debt.
But the partial pullback of the BSP’s QE has diminished financial liquidity manifested by a seeming plateau in M3. (Figure 3, middle pane)
And financial liquidity conditions haven’t been helped by increased bank credit expansion.
The thing is, the brunt of the liquidity drawdown has been in financial assets. The peso, fixed income securities, and stocks had been under pressure.
Reduced bank credit expansion to the financial industry (monthly) has coincided with the decline of the PSEi 30. (Figure 3, lowest window)
The pruning of institutional margin trades may have incited low volume liquidations.
V. The Relationship of Vote-Buying with Politicized Economic Distribution and Public Spending; The Seeds of Political Dynasty, Cronyism and Corruption
But there is more.
Credit financed public spending, including election spending, also plays a crucial role in the price pressures.
People hardly connect the relationship between public spending, politicized economic distribution, and central planning with economic imbalances, governance issues, and corruption.
The great journalist Henry Louis Mencken wrote,
The state—or, to make the matter more concrete, the government—consists of a gang of men exactly like you and me. They have, taking one with another, no special talent for the business of government; they have only a talent for getting and holding office. Their principal device to that end is to search out groups who pant and pine for something they can’t get, and to promise to give it to them. Nine times out of ten that promise is worth nothing. The tenth time it is made good by looting A to satisfy B. In other words, government is a broker in pillage, and every election is a sort of advance auction sale of stolen goods.
H. L. Mencken 1956, A Carnival of Buncombe, Edited by Malcolm Moos, Sham Battle by H. L. Mencken Start Page 323, Quote Page 325, (“Baltimore Evening Sun” article dated October 26, 1936), Published by Johns Hopkins Press, Baltimore, Maryland, Quote Investigator.
Take vote-buying.
Generally, direct vote-buying is considered immoral.
But most people seem to forget that when political candidates promise to spend other people’s money, more specifically taxes, for a specific interest group to acquire their votes, also represents vote-buying!
With the exception that such promises represent an indirect means to buy votes.
The next item is, what drives political candidates to buy votes? How will it be paid?
The simple answer is that the expected payoffs from the political rent-seeking opportunities are much greater than the unscrupulous election investments.
All these go to demonstrate the close connections between direct and indirect vote-buying.
For instance, promises to build infrastructure. Political-economic agents benefiting from infrastructure spending, whether PPP or direct, are likely to shell out money to buy votes directly to have their preferred politicians elected to secure their financial and economic interests.
Furthermore, the more resources and finances spent by the government, the greater the incentive for political-economic agents to engage in underhanded means to have their preferred politicians get elected.
Briefly, rent-seeking and public spending breed and nurtures political dynasties, cronyism, and corruption.
In this context, a change of leaders from democratic elections will not resolve such issues but only rearrange the assignment of political-economic agents in charge of the politicized economic distribution from centrally planned governance.
I call these "personality-based politics." Elections mostly deal with the symptoms than the disease.
VI. The Influence of Publicly Financed Election Spending on the Economy
While the growth aspects of the prospects of election spending enthrall many mainstream economists, they seem to forget that there are other adverse ramifications. Aside from the ethical dilemma, since credit expansion or monetary inflation finances it, such affects prices, the allocation of resources, debt, and many more.
The point is: taxpayer money financed election spending also contributes to economic imbalances.
Data from the Bureau of Treasury provides circumstantial evidence of it. We suspect that election spending has fired up the recent surge in LGU allocation.
Figure 4
Bureau of Treasury allocations to LGUs reached near-record levels since Q4 2021. In %, growth of LGU allocations has soared by at least 25% since December 2021. (Figure 4, upmost pane)
Yet, what if the LGUs spent a substantial segment of this budget on the printing, distributing, and affixing election campaign materials in their locality? Did they also hire people for such tasks?
Also, what if LGUs used treasury allocations instead to mobilize, transport, and pay for crowd participation in massive election rallies? What if LGUs used indirect channels to bankroll organizers and poll watchers?
If our suspicion is accurate, then who pays for the election binges? Won't the taxpayer and the peso holders bear the brunt?
Since there is little skin in the game, would this not motivate the incumbent politicians to entrench their positions by whatever means possible in the elections?
A news anecdote reinforces the insatiable pre-election spending appetite by LGUs.
Aside from the allocations, LGUs even borrowed to finance their spending!
Inquirer, March 15: Separately, the latest data of the DOF’s Bureau of Local Government Finance (DOF-BLGF) also on Tuesday showed that local government units (LGUs) borrowed a total of P5.7 billion from January to February this year, as reflected in the certificates of net debt service ceiling and borrowing capacity (CNDSCBCs) they submitted to the BLGF…In February alone, the BLGF issued 22 CNDSCBCs worth P3.5 billion to 22 LGUs — one province, six cities and 15 municipalities — which had a combined borrowing capacity of P13.7 billion. LGUs’ borrowings in February were mostly intended for the procurement of heavy equipment. as well as construction of public markets, hospitals, roads, solid waste facilities, sanitary landfills, cemeteries, and housing projects, among other local infrastructure, BLGF data showed. Last year, LGU borrowings hit a record P96.7 billion, as a flurry of local projects were started and fast-tracked a year before the elections in May and despite LGUs’ larger share in the national budget from all tax collections alongside their devolved functions and bigger responsibilities.
Huh? Panic borrowing by LGUs to spend on assorted 'public goods' right before elections? What's the hurry?
That’s unless one would milk the pre-election period for personal agenda.
VII. The Money Supply Cycle of National Elections; Milestone Deficits and Debt!
And the borrowing and spending spree of the LGUs are in part manifested in the monetary system.
Don’t you know, the money supply has its cycle during the elections?
The mini-cycle starts in Q4 of the year before the elections. Then it peaks in March to June of the election year. (Figure 4, middle window)
From the nadir of December, the growth of cash in circulation continues to accelerate. It was up 13.5% in March 2022, despite the slowing M3.
While its growth rate in 2022 has lagged two of the three previous elections, it ascended from a high base. At Php 1.869 trillion in March 2022, this represents 1.44x, 3.27x, and 7.7x the levels of 2016, 2010, and 2004, respectively!
At the end of the day, inclusive of elections, public spending magnifies demand that contributes to the price pressures in the economy.
Public spending (monthly) has been on an uptrend since at least 2019, coinciding with the rising trend of the CPI. (Figure 4, lowest pane)
Nominal spending currently hovers at the record highs of December 2021 and has been eclipsed by two other episodes in December 2019 and 2020.
That’s right. Spending boosters usually happen at the end of the year. Yet here they go, spending like a drunken sailor headed through the National Elections!
Figure 5
The relentless increase in public spending has pushed fiscal deficits to the second-highest in history as public debt etched a fresh milestone of Php 12.7 trillion! (Figure 5, topmost window)
VIII. Domestic Price Pressures from the Weakening Peso
There is the currency effect too.
Aside from surging inflation worldwide, the surging USD magnifies domestic price pressures.
The USD-Php was up .59% this week to nestle at its resistance. The rising cost of international financing should weaken the hands of the BSP to maintain the Gross International Reserve (GIR) and the peso at the current levels. (Figure 5, middle pane)
The BSP’s GIRs this April slightly dropped by .88% (YoY). But it looks as if it is on a topping phase. (Figure 5, lowest window)
Therefore, domestic price pressures will not only stem from higher global inflation but also from a weaker peso.
IX. The Structural Foundations of Inflation: A Centrally Planned Government
Figure 6
And why would price pressures in the economy not persist?
With monetary policies exceedingly "behind the curve," the BSP seems to adhere to the use of the inflation tax to relieve outstanding public liabilities. Or, by keeping the CPI artificially down, part of its unpublished goal is probably to "inflate away" the public debt.
"Real" interest rates are at record lows represented by the spread between BVAL 10-year and 1-year rates. (Figure 6, top)
Also, the difference between the PDS 10-year bond yield and the ON RRP of the BSP has surpassed the 2018 highs. (figure 6, bottom)
In 2018, the BSP ON RRP rate was at 3% and the 2012 base anchored the CPI, while public leverage, measured by the outstanding bank credit portfolio and public debt, was 30.8% lower than March 2022.
Then, the surging CPI prompted the BSP to spike its ON RRP by 175 bps in 7 months!
Even with all the relief measures in place, can the BSP afford that today?
As noted above, the CPI has been on an uptrend since 2015.
Its uptrend is structurally supported, which means it is not "transitory."
Critical forces such as the mounting leverage in the financial system, the escalating malinvestments, the fiscal, and most importantly, the BSP's response to these only embeds its upward trajectory.
Most of these have been anchored on the thrust to centralize the political economy.
Regardless of how authorities sanitize it, street inflation will continue to the upside, with occasional speed bumps from a downdraft in the economy.
Despite the CPI pronouncements, the Treasury markets continue to ignore the data and see a sustained march upwards.
Blaming the US Federal Reserve and the Ukraine war should be a strawman. While some factors from these events influence the economy, the CPI has been rising since 2015 or at least has re-accelerated since 2019.
That said, ascendant stagflation risks notwithstanding exploding debt and systemic leverage will remain a critical obstacle to the economy and financial system regardless of who wins the election.
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