Inflation is the process of a great increase in the quantity of money in circulation. Its foremost vehicle in continental Europe is the issue of non-redeemable legal tender banknotes. In this country inflation consists mainly in government borrowing from the commercial banks and also in an increase in the quantity of paper money of various types and of token coins. The government finances its deficit spending by inflation—Ludwig von Mises
In this issue:
A Review of June and 1H 2023 Philippine Budget Deficit, The Eleven Ramifications of Deficit Spending
I. The Connection between Deficit Spending and the BSP’s Policy Stance
II. June and 1H 2023 Deficit Spending, the Escalating Carrying Cost of Public Debt
III. Eleven Ramifications of Central Bank and Debt-financed Deficit Spending: The Crowding Out Effect
IV. Additional Implications of Central Bank and Debt-financed Deficit Spending: Increased Dependence on Foreign Savings and Inflationary Bank Credit
V. More Repercussions of Deficit Spending: Increased Centralization, Rising Taxes, Monetization of Debt, and Reduced Civil Liberties
A Review of June and 1H 2023 Philippine Budget Deficit, The Eleven Ramifications of Deficit Spending
The Philippine budget deficit expanded in June but shrank to its lowest level in 4 years in the 1H. This post explains the 11 tectonic ramifications of deficit spending under the current setting.
I. The Connection between Deficit Spending and the BSP’s Policy Stance
We begin this article with a trenchant quote from the great philosopher Ayn Rand. (bold mine, italics original)
Inflation is not caused by the actions of private citizens, but by the government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bank robbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments. (Rand, 1962)
Let us now see how this applies to the present developments.
What's the relationship between the three recent news articles?
The first represents the government’s fiscal conditions of last June.
Manila Standard, July 28, 2023: The government’s budget deficit widened 4.6 percent in June to P225.4 billion from P215.5 billion a year ago as revenue collection fell 7.91 percent, the Bureau of the Treasury said Friday. It said this brought the budget gap in the first half to P551.7 billion, although this was 18.17 percent lower than the shortfall of P674.2 billion in the same period last year. The first-half figure was also 28.49 percent below the P771.5-billion mid-year deficit program.
The next signifies the incredible U-turn by the new BSP chief on their proposed policy stance.
GMA News, July 6, 2023: The Bangko Sentral ng Pilipinas’ (BSP) policy-setting Monetary Board is likely to consider cutting interest rates within the year if inflation rate falls to 4%, the central bank’s new governor, Eli Remolona, said.
Inquirer.net, July 18: MANILA -It is still too early to put interest rate cuts on the table as upside pressures on prices remain even if inflation is on a downtrend, according to Bangko Sentral ng Pilipinas Governor Eli Remolona.
Long story short, as the nation's biggest borrowers, monetary authorities desire to keep interest low to finance the political boondoggles—via deficit spending.
The same agency also aims to maintain a certain level of price inflation through the rudiment of their monetary policy, called "inflation targeting."
There are, in essence, three ways to finance deficit spending: taxes, debt (future taxes), and inflation.
Keeping interest rates below inflation is part of Financial Repression channeled thru the inflation tax.
This implicit tax represents a subsidy to public debt through payments based on below-market rates and through a debased currency. Or the inflation tax redistributes finances and resources from savers to the authorities and their cronies.
And so, the baseline response of authorities will be to keep rates down to maintain the status quo.
For unstated reasons, Philippine authorities have been reluctant to raise rates compared to many Latin American peers. For instance, the central bank of Chile raised their policy rates from .5% (July 2021) to 11.25% (October 2022)—or by 1,075 bps—in just 13 months in the face of a technical recession! But they have started the ball of interest cuts rolling with a surprise 100 bps last week.
II. June and 1H 2023 Deficit Spending, the Escalating Carrying Cost of Public Debt
Let us see the current fiscal conditions under this prism.
Figure 1
First, compared with the past, where revenue growth outpaced spending growth mainly due to base effects, June's conditions deviated from the recent norms; spending YoY growth decreased marginally by 2.6%, while revenues plunged by 7.9% YoY.
As a result, the budget deficit swelled by 4.6% to Php 225.4 billion—the largest monthly deficit in 2023.
From the currency level perspective, June revenues plummeted below its exponential trend line, while spending remained above it. Since May 2020, except for several occasions, revenues generally trended below the exponential trend line—this means revenues have barely recovered from their pre-pandemic state. (Figure 1, topmost chart)
While some news articles allude to the drop in the 6-month deficit to "underspending," peso-level public expenditures are at a fresh record even as this reflected a slight (.42%) change % YoY. (Figure 1, middle window)
For them, it appears that public spending comes only with benefits. If true, the Soviet Union and North Korea would be the wealthiest nations.
To add, June's deficit contributed a substantial 40.85% to the 6-month deficit of Php 551.72 billion.
By extension, though signifying a decline for the second straight year and the lowest level since 2019, this year's deficit pushed the Department of Treasury's (DoTr) 6-month financing up by 29.8%. (Figure 1, lowest graph)
In turn, higher financing could translate into a new record level for June's debt, which the DoTr should announce soon. Public debt last May 2023 stood at a historic Php 14.906 trillion.
Figure 2
Consequently, the share of interest payments alone jumped to 11.7% of total expenditures—its highest level since 2009. (Figure 2, upper chart)
Including amortizations, the carrying cost of debt reached Php 907 billion in the 1H—only 29% off the 2022 annual record of Php 1.293 trillion. (Figure 2, lower diagram)
And at the current pace, debt servicing (annualized) could hit Php 1.8 trillion, which translates to 34.5% of the 2023 budget target of Php 5.268 trillion.
The 2023 budget allocates only Php 611 billion to debt servicing.
III. Eleven Ramifications of Central Bank and Debt-financed Deficit Spending: The Crowding Out Effect
But consider these: There are eleven tectonic implications of central bank and debt-financed deficit spending operating under the current environment.
1. Rising debt servicing (interest payments and amortizations) will increasingly crowd out other public expenditures (welfare, infrastructure, military, education and etc.). The subtle message is that the pace, or the growth rate of public debt, will have to increase meaningfully to cover the political spending gaps.
Figure 3
2. Increasing debt and its servicing should crowd out investments and consume the public's savings. Deficit spending also competes with the private sector for resources.
Reduced investments lead to diminishing production, which should magnify supply-side deficiency that raises the risk of inflation and interest rates. Competition for access also increases pressures on price levels in the economy and interest rates.
The acceleration of public spending has coincided with the surge in the CPI. (Figure 3, topmost window)
The M2 Peso deposits growth rate has subsided along with raging deficits. (Figure 3, middle chart)
3. Public spending does not raise the CPI only, which signifies changes in the price levels of consumer spending, but it also boosts tax collections. (Figure 3, lowest graph)
Figure 4
It is no coincidence that the recent fall in the CPI diffused into Public Revenues and the BIR collections (-5.07% last June). Remember, nominal/current prices determine the tax collections. Therefore, price levels help shape revenue/collection activities. (Figure 4, topmost pane)
IV. Additional Implications of Central Bank and Debt-financed Deficit Spending: Increased Dependence on Foreign Savings and Inflationary Bank Credit
4. With low savings, the economy will increasingly depend on overseas capital.
But FDI flows fell by 14.1% in April 2023 and 18.05% YTD in April. Yet, debt comprised 70.75% and 76.87% of overall flows. At the very least, FDI flows have been downtrend since December 2021. (Figure 4, middle chart)
Or, domestic investments will require funding from external borrowings that raise the risks of FX shortages or a Balance of Payment (BoP) crisis. Published external debt zoomed to historic highs in Q1 2023. (Figure 4, lowest chart)
5. The economy will increasingly depend on inflationary bank credit expansion unbacked by savings.
Figure 5
6. Rising public debt and bank credit (or system leverage) amplifies interest rates and credit risks.
System leverage is at an all-time high in the face of BSP's policy rates at a 16-year high (as of May 2023). (Figure 5, topmost graph)
How will this affect the deepening liquidity mismatches in the financial sector?
More to the point, banks have increasingly cornered the financial system's resources, aggravating concentration risks.
Universal-commercial banks and the total banking system control a massive 77.4% and 82.4% share in May—near all-time highs. (Figure 5, middle chart)
V. More Repercussions of Deficit Spending: Increased Centralization, Rising Taxes, Monetization of Debt, and Reduced Civil Liberties
7. Deficit spending expands misallocations and increases the scale of politicization or the centralization of the economy.
Or, the political class will increasingly determine or shape economic opportunities based on the amplified expansion of regulatory institutions.
8. With deficit spending (today) financed by a future stream of cash flows, taxes are bound to rise substantially over time.
Figure 6
9. Deficiency in savings means that the BSP and banks will accelerate financing of increasing public debt via (inflationary) money creation or net claims on central government (NCoCG). Increasing the quantity of currency and fiduciary media (money substitutes) circulating in the economy extrapolates to demand expansion relative to existing and available supply. As such, too much money will be chasing too few goods.
The BSP recharged its QE, or its direct funding of the central government, last June, while banks continue to acquire and hold a record number of government securities. (Figure 5, lowest chart)
Both activities inject liquidity into the financial system.
That said, the correlation between BSP’s net claims on the central government and the CPI, although with a time lag, exhibits their causal interactions. (Figure 6, topmost graph)
10. Due to deficit spending, the insufficiency of savings inhibits the development of capital markets.
As deficits diminish savings, decaying trading volume in the PSE has led to the PSEi 30s bear market. (Figure 6, lowest window)
11. Mounting deficit spending reduces civil liberties.
After all, the two roots of the Overtone Window of deficit spending, which signify the fashionable attribution of "inflation" to the supply-side or external factors are:
The first is to conceal the genuine sources of inflation, mainly due to political convenience.
And lastly, to justify the unsustainable status quo moored on Keynesian spending-to-prosperity "trickle down" policies by vested interest groups.
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Rand, Ayn, “Who Will Protect Us from Our Protectors?” The Objectivist Newsletter, May 1962, 18 http://aynrandlexicon.com/
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