Thursday, 8 April 2010

Rising inflation

John Mangun
Outside the Box
Business Mirror
http://www.businessmirror.com.ph/index.php?option=com_content&view=article&id=23871:rising-inflation-&catid=28:opinion&Itemid=64

It is time to throw a little cold water on some of the good feelings about the economy. Yes, there is some bad news that requires some caution for the future. Well, not caution exactly, but some careful thought.

The March 2010 inflation numbers for the Philippines showed prices rising 4.4 percent. Normally I would not even care about that number because I know that inflation in the Philippines is not driven be the “normal” factor of poor government monetary policy and action. The government always keeps a very sensible and prudent approach to the printing of money, unlike in the West.

However, I also know that inflation in the country is driven by high fuel prices, and that is exactly why the March inflation number was over 4 percent. The fuel, light and water component of the inflation index went up 14.6 percent because of higher charges in electricity as well as gasoline and diesel.

There is an absolute truism about the Philippine economy. Inflation rides on oil prices. Oil prices have been going higher. Since the end of 2009, oil has risen from $70 per barrel to $85 per barrel, an increase of about 20 percent. Not good for our inflation rate.

To put things in peso terms, a barrel of oil in late 2009 cost us about P3,255; based on the latest peso exchange rate, that same barrel is priced at P3,820. That is an increase of about 17 percent in peso pricing.

It must be remembered that the primary mandate of the Bangko Sentral ng Pilipinas (BSP) and its policies is to keep inflation under control and manageable. Further, the BSP is committed to price stability.

While the most common method that central banks use to try to manipulate prices and the economy is through moving interest rates higher and lower and by printing or not printing money, the BSP uses the manipulation of the peso exchange rate as its primary inflation-control mechanism. And it works well.

I have the highest regard for the professionalism, intelligence and competency that the BSP has exhibited over the last 15 years or so. The policy implementation by the BSP in conjunction with the Department of Finance has kept this economy from going down the drain on numerous occasions. Too bad the rest of government is not run the same way.

As oil prices have gone up (an economic killer), the BSP has allowed the peso to appreciate, although a little late in the oil-price increase run.

I know that the BSP has been hoping that the oil increase up to $75-78 would be only temporary. But now the oil-price increase cannot be ignored and the peso is going higher. The BSP must balance the needs of all sectors of the economy with regard to the peso. But even with all the complaining by the export sector of a rising peso and the potential loss of export-price competitiveness, the BSP knows that the exporters (and remittance receivers) will be just as badly hurt if gasoline goes 20 percent higher as it easily could if the peso is too low.

The BSP has refrained from allowing the peso to appreciate because there is no supply/demand reason for oil to be at $85. What you read in the newspapers about oil going higher because the US economy is getting better is pure nonsense. Fuel inventories continue to be high in the West because consumption is down.

What has caused higher prices is a growing mistrust in the value for paper money.

The dollar has been going up. That should bring oil prices down or at least keep prices flat. But the only reason the dollar is going up is that the euro has been crashing because of the knowledge that billions of euros are going to have to be printed to bail out Greece and the rest of the failing economies in Europe.

Yet the European situation is just the beginning of the bailouts and the massive printing in large quantities of more paper currencies. The state of California, were it not part of the US, is the eighth-largest economy in the world. And the California state government is bankrupt with about $68 billion in debt. That is nothing when compared to Greece with some $400 billion of problem debt.

But when you factor in all the US states with debt- paying problems and all the major cities, the debt bailout will potentially be huge, creating another wave of dollar weakness. Now this scenario may or may not happen over the next months, but oil is pricing a risk factor in, just in case all currencies, including the dollar, weaken against general commodity prices like gold and oil.

Commodity prices look like they are ready for a substantial breakout to the upside. This would mean the attractiveness of the major currencies is poor. Smaller currencies like the peso would trade almost like a commodity, trending higher, which would offset the dollar price increase of oil.

Over the next few months, we will probably see rising world oil prices to $100 and perhaps higher. The peso will continue to go up. The stock market will continue its rally.

It is also likely the Chinese will slightly appreciate the renminbi, causing more dollar weakness.

Rising oil and a weakening dollar will put great pressure on the US economy which, could bring another round of sovereign-debt failures, a bursting of the Chinese bubble, and a rush to safety which could be very favorable to less-affected nations like the Philippines.

There is not any substantial bad news on the horizon for the Philippines. But some caution may be warranted.


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