Thursday, 26 May 2011

Inflation or deflation: PHL can prosper

Business Mirror

There is not anything resembling “business as usual” for the global economy today. The situation will not return to what we expect as normal any time soon. Anyone who says otherwise is a fool or a liar.

From the PIGS (Portugal, Ireland, Greece, Spain), we now have the PIIGS to include Italy. Italy’s fiscal outlook has just been downgraded to negative.

The West is smothered in debt. Spain’s outstanding debt owed to other nations’ banks is over $1 trillion. Italy’s debt is nearly $1.5 trillion. By comparison, Greece owes about $250 billion. There is not enough economic activity in the West to create the wealth necessary to pay off those amounts. And to keep those economies alive, all the Western countries need to keep borrowing more. It is an impossible fiscal situation.

There are only two options available. One is to allow both sovereign government and bank debt defaults whether they eventually call it restructuring, reprofiling, or readjustment.

Major banks will fail. Lending will come to a halt, as will economic activity. The standard of living will drop like a rock. Governments will be forced to stop most of the social safety nets as interest rates will go up to very high levels on any lending that is available. Forty-five million Americans depend on the government for at least a portion of their daily bread. Commodity prices will fall significantly as people will simply be too poor to buy goods and services. Wages will drop as companies will have a large labor pool willing to work for much less just to survive.

Those who see this outcome for the future believe that we will see oil at $25 a barrel, as well as gold at $250 per ounce. And the US dollar will rise 50 percent from its current value, as any performing loans that are still around will need to pay creditors in dollars. Further, the US will be the only safe haven from social and political unrest and chaos.

Imagine an individual overwhelmed by debt. Finally, giving up ever trying to pay, the bank is called to take back the house, the car is returned to the finance company, and all the goodies are sold at a garage sale just to buy food as the old lifestyle dies and a new poorer way of living starts.

That is the deflation scenario.

Unlike you and me, governments can create money. A government needs funds to pay its debts, just print it. If no one wants to buy government debt, have the central bank print the money and buy government debt issued by the Department of Finance or Treasury. We call this Quantitative Easing (QE). If the banks or corporations have problems paying their debts, print more money and loan it to them at near-zero interest rates. Bail them out.

QE is nothing more than currency debasement. The Roman Empire was destroyed as the emperors debased the value of the currency. Wanting to spend money the government did not have, they just created more currency. From about A.D.190 to around A.D. 290, the silver content of Roman coins went down from 95 percent to 0.5 percent. Prices increased by 1,000 percent. Since the creation of the US Federal Reserve in 1913, the US dollar has lost 95 percent of its purchasing power. What cost $1 in 1914 now costs $21. Put another way, the price of that $1 item in 1914 has increased 2,100 percent in less than 100 years.

The rate at which money is now being created and currencies debased can lead to hyperinflation. That is the inflation scenario.

Continued debasement of currencies gives the impression of economic growth just as the emperor Caracalla doubled soldiers’ salaries with a silver coin worth as much.

The ‘inflationists’ believe that governments will not take the social turmoil and economic downturn that deflation brings and will continue QE hoping that the economies will recover. Governments are willing to risk the threat of hyperinflation.

One of these two scenarios, at least to some degree, will happen in the next one to two years. It is inevitable.

The Philippines, like several other nations (Thailand and Malaysia, for example), will escape the brunt of the potential coming disaster.

A deflation event will slow growth but we have several things going in our favor unless the government totally makes a mess of it.

Domestic output and local consumption is strong, much stronger than in China, for example. Outsourcing is a crucial income earner, and this business would even grow stronger in a period of Western deflation as companies reduce costs to survive. Overseas workers’ remittances will continue, if not exactly grow. Spain has more than 20- percent unemployment, yet Spain’s Filipino worker remittances are up 17 percent over 2010. The Philippine economy is not dependent on manufactured goods exported particularly to the West. Likewise, the Philippines is not a commodity exporter, prices of which would fall dramatically during a deflationary period. Beneficially, the prices of commodities that we must import would be cheaper. The Philippines does not have any asset-price bubbles: real estate, wages, stock market.

Currency-induced cost-push inflation is the fear of “inflationists,” and it is all about the US dollar.

The dollar will fall severely in terms of purchasing-power value. Gold will go to $2,000 and oil will see $200. All hard-asset prices will rise, including stock markets and commodities. Although interest rates will increase, bank lending will also rise. The world will be flooded with less valuable currency.

Imported goods and raw materials could go up significantly in the Philippines. That is the worst scenario. However, the Bangko Sentral ng Pilipinas has the ability to mitigate this by increasing the value of the peso to offset increases in the price of imported goods. However, it comes at a cost. Fortunately, we have enough foreign-currency reserves to help maintain the value of remittances in peso terms and to help maintain the flow of foreign direct investment.

Regardless of what the future holds, the Philippines can prosper through it all. We have a strong domestic economy. Our economy does not rely on the West. Our banking system is financially sound. Our economic house is strong enough to weather whatever storm the global economic condition brings to the Philippines.

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