Thursday, 15 July 2010

Dollar policy or peso policy

Written by John Mangun
Outside the Box
Business Mirror
http://www.businessmirror.com.ph/index.php?option=com_content&view=article&id=27600:dollar-policy-or-peso-policy&catid=28:opinion&Itemid=64


Even as the Philippines is outside of the financial typhoon blowing around the world, the administration is going to have to face and make some very important decisions in the near term.

The policy of the government for the last 12 months has been to wait and watch, and then react. While a reactive, rather than proactive, policy might be the easiest to implement as it does not require more than creating some “what if?” scenarios, last month the world situation changed in a way that the government must now take an economic-policy stand and go on the offensive.

Often, the best economic policy that a smaller economy like the Philippines can pursue is to follow the major nations and make adjustments as necessary for local conditions. As the world fell deeper and deeper into the economic black hole, the government reacted by pumping billions of government-borrowed money into so-called stimulus programs. This debt-based spending was accompanied by a massive inflation of their money supply by turning on the currency printing presses.

Simply stated, the disease that inflicted the world economy was the cancer of too much bad debt issued by the world’s banks and financial institutions. When these institutions realized that they could not afford to issue any more debt, lending around the globe stopped. And the result was the symptom of the disease, a slowdown and contraction of economic activity.

Government stimulus was an attempt to get the global economy moving again. And to help cure the disease of a stop of bank lending, governments lowered interest rates to make money cheaper in an attempt to get the banks to start lending again.

The combined actions of stimulus and low interest rates failed because the banks used bailout money and low interest rates to improve their balance sheets while not writing off the bad debt. The banks are still carrying the bad debt and the banks are still refusing to lend. Government stimulus money could never take the place of lending as an economic stimulant.

The Philippines followed by spending a reasonable amount of public money in stimulus efforts, more as a way of showing that the government was standing by to assist the economy, rather than taking over the job of economic activity as the West did.

The Philippines lowered interest rates as a way to keep banking lending robust. The policy of the government has been successful in that economic activity has been strong and bank lending has continued throughout the last 12 months.

In Canada last month, the G-20 nations met to discuss future policy. Now the global situation has changed and the Philippines must change its thinking. The US intends to pursue the policy of continued government-backed stimulus by borrowing and printing money and increasing both the government’s budget deficit and its borrowings. Europe has made the decision to stop this stimulus policy and pursue austerity and a reduction of government spending, budget deficits and borrowing. This is a big deal.

With the US going in one direction and Europe in another, entirely opposite to each other, there is going to be a clash at some point. As the US is calling for a strong renminbi, it is in effect calling for a weaker dollar. Europe, on the other hand, is doing nothing to stop the euro from appreciating. The euro has appreciated from €1.20 to the dollar to standing now at €1.26. The US dollar index has fallen from nearly 89 to 84.1 in the same period.

The Philippine government keeps talking about the need sometime in the future to raise interest rates off these very low levels. The reason to raise interest rates is to avoid a situation where there is too much cheap money in the economy, causing inflation. But inflation forecasts for the country are very low. If low rates are good for the economy and there does not seem to be any bad side effects, then why raise rates? There aren’t any sound reasons to raise interest rates…for now.

The US wants low interest rates and a weak dollar to keep its government borrowing costs low and to be able to pay back its debt with cheap dollars. The world will tolerate this policy only so far. Foreign governments and financial institutions have seen the value of their dollar holdings drop in relation to their local currency, and that trend cannot go on forever.

At some point, countries, primarily China and Japan, are going to say that it is not in their best interests to keep funding the US government and economy with their dollars that keep becoming less and less valuable as they carry the US debt. China has already made clear that it will keep the option of bailing out and dumping dollars if this US government policy continues.

The Philippines is going to have to make a conscious decision to stay with the dollar and risk a dollar-depreciation disaster that would be seen as a huge spike in inflation, as imported goods like oil skyrocket. Alternatively, the Philippines will choose to chart its own economic-policy course.

Other Asean members are in the same situation. The combined foreign-exchange reserves of Singapore, Malaysia, Thailand, Indonesia and the Philippines have ballooned in the last two years. These countries are sitting on hundreds of billions of dollars, and those dollars are a potential disaster for their economies. From BusinessMirror: “The end-June reserves could cover nine months of imports of goods and payments of services and income, and were equivalent to 9.3 times the country’s short-term external debt based.” The Philippines is covered with dollars that no one may want in the future.

Now here is the dilemma. The Philippines should strengthen the peso by unloading some of its dollar reserves. Rather than raise interest rates, which are high in comparison to our neighbors and would not be necessarily beneficial to the economy, the government needs to sell dollars.

We cannot continue to wait and react. The government must decide if we are going to ride on the US government, economy and dollar. Or if we are going to plan and execute an independent economic policy.


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