The Untold Story of the August CPI: The "Snowballing Effect" of Inflation and Consumer Financing (and Election Spending) as the Primary Culprit

 But here is an unspoken truth: inflation also makes us worse people. It degrades us morally. It almost forces us to choose current consumption over thrift. Economists call this high time preference, preferring material things today at the expense of saving or investing. It makes us live for the present at the expense of the future, the opposite of what all healthy societies do. Capital accumulation over time, the result of profit, saving, and investing, is how we all got here today—a world with almost unimaginable material wealth all around us. Inflationism reverses this. So this very human impulse, to save for a rainy day and perhaps leave something for your children, is upended. Inflationism is inescapably an antihuman policy—Jeffrey Deist 

In this Issue 

The Untold Story of the August CPI: The "Snowballing Effect" of Inflation and Consumer Financing (and Election Spending) as the Primary Culprit 

I. Political Agenda Influencing The Calculation of the CPI 

II. The Understatement of the CPI through Statistical Magic of Rebasing, Redux 

III. Treasury Markets Rejected the CPI! 

IV. The USD Peso Record Streak Dismissed the CPI! 

V. The "Snowballing Effect" of Inflation 

VI. The Money Illusion: Inflation Overwhelms Imports and Manufacturing! 

VII. Consumer Financing (and Election-Public Spending) as the Primary Culprit for Inflationary Crisis   

VIII. If the August CPI was Below the High of 2018, then Why the BSP’s Historic Tightening? 

 

 

The Untold Story of the August CPI: The "Snowballing Effect" of Inflation and Consumer Financing (and Public Spending) as the Primary Culprit 

 

Authorities told us that the statistical inflation, represented by the benchmark CPI, slipped to 6.3% from 6.4% this August. 

 

According to their numbers, lower prices in the food and transport sectors pulled down the headline numbers.   

 

But they haven't told us the following. 

 

I. Political Agenda Influencing The Calculation of the CPI 

 

The newly inaugurated President "disagreed" with the June CPI report last July.   For PR purposes, perhaps, the presidential advisers persuaded him that the CPI represented "imported inflation."    

 

The Philippine Statistical Authority (PSA), an attached agency of the National Economic Development Authority (NEDA), calculates and publishes the CPI. The President chairs the NEDA.   

 

The PSA states in its primer that the CPI is "used for economic analysis and as a monitoring indicator of government economic policy."   

 

The same agency writes that its components "are used as deflators for most personal consumption expenditures (PCE) in the calculation of the gross national product (GNP)" and as a "basis to adjust wages in labor-management contracts as well as pensions and retirement benefits." 

 

As it is, perhaps the CPI is the most politically sensitive statistic.  

 

Officially disclosed, it affects the headline GDP, the minimum wages set by the government, and public welfare programs.   

 

More to this point, the PSA didn't say that aside from the GDP, another use of the CPI is for direct and indirect tax forecasting.  

 

Another crucial role of the CPI is that it influences interest rates, which affects credit conditions and the ability of the government to spend. 

 

That is to say, a managed or gradual increase in the CPI benefits the government immensely.   The BSP call the thrust of their monetary policy "inflation targeting." 

 

Nonetheless, presented as economic development, authorities use the spending-based GDP to justify this redistribution regime.   

 

But there are hitches.   

 

While authorities highlight the benefit of its actions through the GDP, they seem to ignore its costs.   

 

Aside from the escalating debt levels, the rising street prices function as the release valve of economic maladjustments.   

 

That is, a disorderly ascent of the CPI reduces the GDP.     

  

It also raises interest rates, which increases the cost of funding for public debt and the biggest debtors, affecting corporate earnings and magnifying credit risks. 

 

It also exposes the embedded malinvestments.  

 

Rising rates also diminish the wherewithal of authorities to engage in spendthrift ways to promote their political agenda.  It does so by reducing tax intake directly as the economy sputters. 

 

And through the re-emergence of "positive real rates," implicit subsidies to public debt and the biggest borrowers corrode, restricting public spending and curbing wealth-consuming bubble activities.  

 

So the inherent incentive of authorities is to declare or publish a lower CPI. 

 

While the principal cause of inflation is the government, primarily through artificially lowering rates that facilitate credit expansion, as evidenced by money supply growth, it has been made worse by manifold supply-side mandates, edicts, and interventions.   

 

However, for political convenience, authorities blame "greed" on some of the individuals engaged in its trade or some exogenous forces.   

 

So the public is presented with news of hoarding, which signifies symptoms of intensified scarcity. 

 

From this perspective, if the leadership doesn't believe in an elevated CPI, it's easy to instruct their subordinates to show a lower, more politically palatable figure.  

 

Therefore, "disagreement," "imported inflation," "hoarding," and other pretexts or smoke screens are merely extended expressions or symptoms of this blame-shifting syndrome.  

  

And because the CPI is just a statistic constructed by authorities that aren't subject to competition or audit, the numbers produced may be made to conform to their political agenda. 

 

"If you torture data enough," a piquant quote popularly attributed to the late economist Ronald Coase, "it will confess to anything." 

 

II. The Understatement of the CPI through Statistical Magic of Rebasing, Redux 

 

Since rebasing the CPI to the 2018 base year, the PSA published the CORE CPI for the first time with the August data.    

 

However, like a footnote, the core CPI was not only tucked away or buried in tables 10-11, but the data covered a meager one year!  

 

Figure 1 

 

But here is the thing.  The difference between the 2012 and the 2018 base rates had an average of a whopping .84% in 5 months!   Or the difference between the 2018 and 2012 CORE CPI was almost 100 bps! (Figure 1, topmost pane) Incredible. 

 

The 2018 core CPI jumped to 4.6% in August from 3.9% in July and may test the 2012 base high of 5.1% etched in November 2018.   

  

Please observe that after a long-term decline (1995-2015), the CORE CPI has reversed course; it subsequently trended upwards since 2015.   And the chart includes the sanitized 2018 data applied at the start of 2022! (Figure 1, middle pane) 

 

The spike in the core CPI, which excludes energy and food, manifested price increases in most segments, which exhibits the widening coverage of rising prices across goods and services. 

 

Of the ten non-food and energy segments, eight posted increases led by the CPIs of education at 3.8% in August from .6% a month ago, Personal and Misc at 3.3% from 2.8%, and Household furnishing and maintenance at 3.4% from 3.1%. Yes, you read that right; the education CPI rocketed sixfold! (Figure 1, lowest window) 

 

The point is price pressures, even according to their numbers, continue to percolate into the broader segment of the economy.  

 

As an aside, using the 2012 base rates, the headline CPI would extrapolate to about 6.9% or 7%, a multi-decade high.   

 

To be sure, authorities will attempt to suppress the CPI from toppling the September 2018 apex of 6.7% (2012 prices). 

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).  

 

III. Treasury Markets Rejected the CPI! 

 

Authorities can publish what they want, but intermediaries and savers still have a say on this via the Treasury markets.  

 

A media outfit (Inquirer.net) recently published a fascinating oxymoronic headline:  Banks demand higher yields, gov’t says no. 

 

Government is not a wealth creator but a wealth consumer.   

 

But because it requires to absorb savings or financing for its spending and redistribution activities, it will have to either accept higher rates or go back to the BSP for funding necessities. However, the latter entrench structural inflation. 

 

Figure 2 

Proof? 

 

Ignoring the CPI, except for the 6-month T-Bills, yields across the treasury curve surged last week. (Figure 2, upmost window) 

 

Terminal rates rose faster than the front rates, steepening the slope to indicate more inflation ahead. 

 

As such, the spread between the benchmark 10-year yield and BSP rates, which exceeded the highs of 2018 last July, rebounded. (Figure 2, second to the highest pane) 

 

Or, the treasury markets refuse to acknowledge the CPI, portending higher inflation.    

 

To be clear, it is not the BSP in control of the current conditions.  Instead, the BSP is reacting to the escalating inflationary pressures that have fueled higher treasury rates.   Hence, the treasury markets have forced the BSP to raise rates reluctantly!  

 

And no, it is not the US Fed only responsible for the present dilemma. Indeed, rising treasuries yields have been a regional or a global phenomenon. 

 

But measured by the 10-year benchmark, Philippine Treasuries have risen the fastest in the region! (Figure 2, second to the lowest window) 

 

Hence, the underlying conditions of the economies distinguish the impact of Fed actions.   

 

The USD is the world's currency reserve system, thereby the FED's influence on domestic economic and financial conditions is magnified through the currency channel. 

 

Since January 2021, the yield of the local 10-year benchmark has outsprinted the USD counterpart! (Figure 2, lowest window) 

 

IV. The USD Peso Record Streak Dismissed the CPI! 

 

Has the CPI peaked?   Will the BSP "pivot?" 

 

Not so, said the USD peso, which extended its record run through Thursday before pulling back on Friday, along with the region’s currency. 

 

For the week, after reaching an all-time high of Php 57.18 last Thursday, the benchmark FX rate retreated on Friday but still closed marginally higher by .09% to 56.82, which is still above the apogee of 2004. 

 

The USD peso has been instrumental in fanning the recent spike in the core CPI. (see below) 

 

Figure 3 

As a reminder, the USD-Php is among the worst-performing currency in (ex-Japan) Asia, second only to South Korea on a YTD and YoY basis. (Figure 3, topmost pane) 

 

Activities in the treasury markets have resonated with the USD Peso. And perhaps, only the low-key treasury and currency traders know better. 

 

V. The "Snowballing Effect" of Inflation 

 

Please allow me to repeat some of what I mentioned last week with updates.  

 

In 2018, a rice crisis was supposedly the primary reason for the surge in CPI.  

 

Today, the uptick in the CPI has been about scarcities and shortages that spread initially from pork to chicken and then to an assorted array of agricultural products such as sugar, salt, onion, and garlic.    

  

Recent reports floated of the emergence of scarcities or shortages in sardines, which authorities denied.  Interestingly, small fishermen alleged this is a ploy to allow large vessels to tap their fishing grounds.  

  

Some reports also stated that rice prices experienced incremental increases, which aside from insufficient domestic supplies, mounting protectionism, and drought overseas, could aggravate declines in harvests. 

 

India, the second largest source of imports, made good its threat to curb rice exports this week. Four of the five primary sources of Philippine rice imports have restricted exports or raised prices. 

 

Also, to recover losses, San Miguel Global Power has filed with the Energy Regulatory Commission (ERC) a petition for a series of rate hikes in the NCR and neighboring provinces. Electricity prices may jump by 30% starting in October if the ERC "fail to act on their petition"! 

   

The Inquirer reported that an official of the Philippine Chamber of Commerce and Industry (PCCI) recently warned that surging coal prices, reflected in electricity prices, would have a "snowballing effect."  The ongoing power crunch may compel affected firms to pass through the sharp price hikes to consumers or risk stopping operations.   

 

But it could get worst. Since water pumping stations depend on electricity, water prices may substantially increase too!  

 

As warned, should electricity and utility prices spike, will it fuel social unrest here, similar to many parts of the world, including Indonesia? 

 

VI. The Money Illusion: Inflation Overwhelms Imports and Manufacturing! 

 

Imports are at milestone highs! The consensus will interpret the positive sign as "growth" consequential of "domestic demand."  

  

Because imports jumped by 21.5% as exports contracted 4.22% in July, the balance of trade swelled to an unprecedented deficit of USD 5.93 million! 

 

Again, the July data serves as another reinforcement of the nation's intensifying extravagance financed by credit. 

 

Unfortunately, even government external trade data fails to support the idea that domestic demand represents its driving force. 

  

Since June 2020, the share of capital goods and consumer goods to total imports has been declining in the face of soaring fuel imports. The inference is that the primary growth of the sector has been traceable to fuel than capital and consumer goods imports. Yes, it is about higher prices of fuel. (Figure 3, lowest pane)  

 

Furthermore, a correlation exhibits the feedback loop between the rising USD and imports. Or, increases in imports are about higher prices than volume.  (Figure, middle window) 

 

Figure 4 

Even the official data on manufacturing has reinforced the inflation aspect of the sector's performance.  

  

In July, the production value expanded by 10.57% YoY or .5% MoM even as volume grew by only 2.48% or a -.3% MoM. The disruption of price and volume commenced in the 4Q of 2021 and accelerated in 2022. (Figure 4, topmost pane) 

 

The negative spread between the PPI and the CPI also started in 2022 and has remained deeply contractionary. It means that price hikes of goods post-factory has ascended faster than consumer prices. In July, the CPI was 6.4% relative to PPI's 7.89%. 

  

Such dislocation translates to extensive margin losses by wholesalers, retailers, and industrial end-users. The other aspect is that the CPI understates the price hikes at the retailer's point of sale. 

  

The same discontinuity has happened to the differentials of manufacturing sales value and volume. Sales value vaulted by 23.13% in July, whereas volume sales grew by only 14.12%. (Figure 4, second to the highest window) 

 

If accurate, the economy has been overwhelmed by the money illusion. 

  

And to reinforce this, the surge of the PPI, production, and sales value has been bankrolled by booming bank manufacturing loans.  (Figure 4, second to the lowest pane) 

 

The crux is that the previous shortages and price increases spurred the manufacturing sector to respond to the current conditions. It increased capacity, buildup input inventories, and expanded labor belatedly to boost output.  

 

Unfortunately, external demand has started to thin, which implies that domestic requirements should or could follow. Once this occurs, what happens to the excess (input and output) inventories and labor force backing the present expansion? 

 

VII. Consumer Financing (and Election-Public Spending) as the Primary Culprit for Inflationary Crisis   

 

The consensus believes that a consumer boom will backstop the GDP. 

 

This topic adds to our discussion last week on the rocketing growth of salary loans.  

 

First, authorities reported a marked improvement in the job market last July.   (Figure 4, lowest window) 

 

Employment and unemployment rates are at their best showing since the pandemic recession.  

 

Remember, the pillar for the 3Q GDP springs from the assumed spending of this data.  

 

And granting that the labor data represents a proximate estimate of reality, it means that the pickup in bank lending financed investments that prompted job hiring.   Though I doubt this premise, let us go with its logical flow. 

 

Next, it also translates to increases in spending by the employed. 

 

The irony is that BSP recently raised rates to control spending.  

 

Yet, how does the alleged progress in labor conditions support the assertion that the "supply side" and "imported prices" are the only factors driving the CPI? 

 

Separately, we elaborated that the massive interventions of the BSP have spurred the banking system to redesign the functionality of their balance sheets to focus on investments.  

 

But reconfiguration also involved bank lending operations! 

 

The thing is.  Banks are now lending more to consumers than the supply side.  

 

Figure 5 

Because consumer loans have continued to outperform production loans, this reinforces the upside streak in their share of the total loans net of RRPs (reverse repos). (Figure 5, topmost window) 

 

More importantly, since credit cards outshined their other segments, it has been the principal force driving the expansion of consumer loans. (Figure 5, second to the highest pane) 

 

Credit card rates remain capped by the BSP. 

 

And the uptrend, which started in 2015, accelerated in 2019.  It peaked at the onset of the pandemic but quickly rebounded with the backing of the BSP.  

 

Consumer loans, mostly from credit cards, fell during the recession but bounced back sharply along with the CPI.  

 

Or, the strategic thrust of bank lending appears to have been refocused or shifted to consumption than investments and output.  How sustainable can this be?  

 

We include below the real estate spending of consumers via the BSP consumer data.   

 

Here we find that even when general bank lending fell during the pandemic, consumer real estate loans defied the overall trend with sustained expansion.  It slowed alright but never contracted.   

 

The share of real estate consumer loans remains close to the peak. (Figure 5, second to the lowest pane) 

 

Aside from the unparalleled liquidity injections and the relief measures implemented by the BSP, banks sustained the rollover of outstanding loans, perhaps even to delinquent accounts, to avoid defaults from amassing. Furthermore, as the tempo of salary loan growth picked up in 2022, its share of the BSP consumer loans also started to increase. 

 

The point of this exercise is to exhibit the mind-boggling explosion of the consumer balance sheet leveraging to finance spending! 

 

This dynamic didn't appear in a vacuum.   

 

Aside from consumers, post-election spending powered what the mainstream calls "aggregate demand," which contributed to imbalances that led to higher prices.  

 

Though cash in circulation has dropped since the election, it remains close to unmatched heights in April! (Figure 5, lowest pane) 

 

With the surge in consumer financing and excess spending from the election, how is the CPI not primarily demand-driven, exacerbated by supply gridlocks? 

 

And as one would observe, authorities appear to be confused between "containing inflation" and promoting it through a credit-financed GDP. 

 

VIII. If the August CPI was Below the High of 2018, then Why the BSP’s Historic Tightening? 

 

Given the list of a string of records, the BSP embarked on an unprecedented speed of raising its policy rates. 

 

It increased by 175 bps in only four months, from May to August 2022, compared to 2018, which took seven months.  

 

Citing the US Fed anew, the BSP has signaled more rate increases. 

 

Unless the authorities confront reality, financial, economic, and political uncertainties should reign. 

 

____ 

Nota Bene: The newsletter intends to apprise readers of the market conditions based on the information available at the time of the items’ writing, whose accuracy and timeliness of the issues concerned are subject to change without prior notice.   Solicitation to trade is neither intended by the contents. In the meantime, the discussion of occasional positioning on particular issues are opinions of this author.