Wednesday, 10 November 2010

High inflation or peso appreciation

Business Mirror

The world is entering the most dangerous and potentially devastating phase of the global economic crisis.

The US began an economic recession in 2007 as oil prices spiked and the debt bubble was beginning to burst. That debt bubble exploded in full force in 2008, destroying a trillion or so of dollars of assets and bringing to light the terrible financial condition of many so-called first-world governments and first-world financial institutions.

In 2008 and 2009, governments printed trillions of dollars of new money in a failed attempt to stimulate their economies. The plan was that economic activity would increase enough to absorb this new money. Economic activity did not rebound, and the result has been stagnant economies flooded with new money that was not creating wealth but, in fact, was creating a superinflationary global economic environment.

Governments are run by politicians who do not have the capability to think in terms of years but only in terms of quick political expediency. The problems were created by years of short-term policy decisions, and these same incompetent politicians believed that the problems could be solved with more short-term policy decisions. Instead of building economic superhighways to growth, they filled the potholes, hoping that the people would be fooled that everything was just fine. They were wrong as usual

Sound economies must create real wealth, based on people making real goods and providing real services. You just cannot fake it. You cannot put lipstick on a pig and call it a beauty queen. After creating nearly $2 trillions of fake money without any wealth-creating economic results, the US Federal Reserve decided to try that failed policy one more time. Last week the Fed announced it would print nearly another trillion dollars more between now and June 2011.

The first time they printed the trillions was to provide funds to stimulate domestic economic activity. That did not work. This time the purpose is to lower the value of the dollar to increase US exports to increase economic activity. Why are these so-called first-world countries so intent on devaluing their currencies? It is because national governments do not go bankrupt. Currencies go bankrupt. It is the only way to get out of their debt problem. This Fed initiative will also be an economic failure but this policy will most definitely create inflation.

The broadest measure of global commodity prices, denominated in dollars, is the Continuous Commodity Index (CCI). That index reached 600 in July 2008. It is now at 597. But in 2008, oil was priced at $140 per barrel. Now oil is $88. The increase in the CCI is due to dollar devaluation. The CCI is a leading indicator of future global price inflation as it presents raw material costs that will show up in consumer prices.

Inflation in the Philippines is running at 2.8 percent. Compare with the US. In the last 18 months, US prices for gasoline up 30 percent, wheat up 60 percent, corn up 75 percent, cattle up 20 percent, and lumber up 40 percent. And these are the numbers for a nation with little economic growth and where personal income and personal spending is going down. This is the currency-induced cost-push inflation I wrote about last month and it will become a global condition.

Further compounding the inflation problem is that the Fed policy will force Europe to expand its money-printing activities to devalue the euro. As that happens, it is inevitable that currencies like the Philippine peso will rise in value. The peso not only will rise, but must go up in value to protect this economy. We will see 40 to the dollar, then 38, 36, and on and on as the dollar devalues.

Countries like the Philippines have two choices: devalue the currency along with the dollar and be subject to high inflationary pressure or appreciate the currency and adjust to international capital flows.

Look, the Philippines is not like Brazil, which is dependent on exports to the US and, therefore, needs to stay pegged to the dollar. Brazil is also being hurt by “currency carry trade.” That is where financial institutions borrow in dollars at near-zero interest rates and then move the money into Brazil to take advantage of deposit rates as high as 11 percent. Money is moving to the Philippines and others for investment-profit opportunities and currency appreciation, not for high interest rates as such.

The downsides for peso appreciation are supposedly three. I say supposedly because I do not believe that these offset the harm that high inflation will bring.

Exporters are vigorously calling for a weakened peso because they cry that they cannot compete in a peso-appreciating environment. If the exporters are dependent on a third-world depreciated currency, then they do not have any business being in business with that poor a financial model. Also, other nations that compete with the Philippines are experiencing currency appreciation. Finally, the nation must balance the economic contribution of the export sector to the total economy.

Overseas workers will receive less for their remitted dollars. Common sense says that if inflation comes from a depreciated peso, there will be a net loss, as remitted money will get more pesos that have lower purchasing power due to inflation. What do you want? More paper money that buys less or less paper money that buys more.

Outsourcing will be impacted by an appreciating peso. However, other outsourcing destinations face the same situation. Further, the cost differential between home-country service costs and outsourcing is great enough to cover currency appreciation. Do not forget. During the course of our outsourcing boom, the peso has appreciated from over 50 to just over 40 and business continues. And the argument that outsourcing companies will not continue to build in the Philippines is misleading. If these companies can make a profit from their overseas clients, they will build facilities here. Globally, the outsourcing industry has had flat growth for two years. Despite an appreciating peso, business in the Philippines is up more than 20 percent.

There is no choice in this matter. US government policy has put the world on an inflationary path that will cause great economic harm. There is absolutely no reason for the Philippines to get caught in this terrible situation unless we start trying to manipulate the peso to serve narrow, special interests.

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  1. Unfortunately, whilst a lot of what you said is undoubtedly true the rising value of the Philippines Peso is hitting the Philippine tourist industry hard. Major beach resorts which commonly have 90%or more occupancy have seen these figures fall almost month by month. The recession around the world has meant that the Philippines has to fight hard trying to retain it's share of the holiday and leisure markets. In what is a global market prices have to be quoted in a currency understood by the majority and that is unquestionably the US dollar, hence hotels and resorts like this honeymoon resort all quote their room rates not in Pesos but in US dollars
    Devaluing the Peso a little would help to ensure a long term future for the Philippines tourism industry.

  2. The use of the Php as a substitute for the dollar and safe haven for investors escaping the low interest rates and depressed currencies of the USA, Europe and the UK is causing major distortions that I feel the Phillipines has every right to counteract. These are not normal times and the Philippines economy above all requires stability. Keeping the economy stable is Noy Noy's primary responsibility. What we are witnessing, however, is a disproportionate appreciation of the nation's currency in a short period of time. This is bound to lead to long term damage. Were the adjustment to be more gradual maybe the country could absorb such change.

    It may well be that South Korea will start a trend among emerging nations in the plans it has to reduce capital inflows beyond what its economy needs. At present I think the Philippines is hesitating on immitate such measures. If you believe what you read in the newspapers it appears to enjoy the newfound strength of the peso but gives little if any attention to its causes and the potential downside risks if there is no attempt to intervene to remove the irregular distortions caused by too much foreign money coming into the country. It also has, an enormous property bubble funded by these inflows and quite possible by bank lending, although the proportion borrowed and therefore the level of bank exposure in the event of a property crash, is not clear.

    I am all in favour of freely floating currencies in normal times but these are not normal times and the measures taken by the US Federal Reserve sow the seeds not only for its own destruction but also that of emerging nations like the Philippines.

    The Philippines needs to protect itself from the negative effects of US QE.