Tuesday, 24 January 2012

What BSP does not understand about money


JOHN MANGUN
OUTSIDE THE BOX  
Business Mirror
http://www.businessmirror.com.ph/home/opinion/22348-what-bsp-does-not-understand-about-money

THE Philippines has been fortunate over the years to have a central bank led by competent managers. The Bangko Sentral ng Pilipinas (BSP) has usually taken seriously its mandate “to maintain price stability conducive to balanced and sustainable economic growth.” In other words, to control inflation.
The BSP has maintained its political independence for the most part, keeping its policies and actions outside the realm of what might be politically favorable to any and every administration.

It is a formidable job to do and the BSP has been subject to great criticism for not going along with every government policy that was supposed to be good for the economy.

That may have just changed and not necessarily for the better.

Interest rates are the main weapon that the BSP has to keep the economy from “overheating.” An economy that is overheating is one where there is much activity but not necessarily activity that creates sustainable and long-term wealth creation. China has built housing units for 60 million people that are currently unoccupied. The construction of that housing provided a quick fix to their economy and pumped billions into the economic system. However, there are not any long-term benefits to empty apartments.

The BSP controls how much money is in the system and controls the cost of using that money through setting the base interest rates. Too much money at too cheap a price in the system can cause consumption to increase without an increase in production: inflation. Or as in China’s case, an equally harmful increase in production without an increase in consumption: a form of deflation.

The BSP just lowered interest rates by 0.25 percent. “The Monetary Board has concluded that the benign inflation outlook allowed some scope for a reduction in policy rates to help boost economic activity and support market confidence.”

Notice the language. The BSP expects inflation to be low in 2012, so they are lowering interest rates to help stimulate the economy.

You see how this goes against its mandate. The mandate says interest-rate policy is a tool to keep inflation in control, that is, by not allowing too much unproductive money in the economic system.

But now the BSP is saying because the tool it uses to control inflation is working so well, we are going to use that tool for another purpose. Inflation in the Philippines ran at about 4.8 percent in 2011. Look at some other nations’ inflation rates that have used interest rates to “stimulate” their economies: Germany/5.7, Brazil/6.5, Russia/7, India/9.3, and Argentina/9.5. The US has done the same thing with rates and while inflation is 3 percent, there has not been any increase in economic growth.

The downside is that real interest rates, the difference between what you get for your bank deposits and inflation, is now negative. You lose purchasing power keeping money in the bank.

The BSP wants you to take that money out and go build a business, not just spend for goodies because that could be inflationary.

But what the BSP and the administration does not understand is money in the bank and money in a business is not the same thing.

You keep money in the bank because it is immediately available, liquid, and it requires none of your attention. The BSP wants you to take out your P1 million and buy a bunch of food kiosks because that would be good for the economy. But you will not do that. It is an apples and mangoes comparison.

So if you want funds that are liquid and will make you a return higher than inflation, where will you go with your investment? Three words: Philippine Stock Exchange.

We are seeing that happening every day at the stock market. And investors will make more money in stocks than in food kiosks with a lot less headaches.

The other fallacy of the BSP’s decision is what they will do when inflation goes up if oil prices spike 20 percent. The BSP will probably raise interest rates, killing their economic-stimulus idea.

Would the stock market fall if that happened? Very briefly because if inflation rose to, say, 6 percent and the BSP raised rates back to where they were before this cut, negative interest rates would be even worse, making stocks even more attractive to investors.

There is an old saying, “If it’s not broken, don’t try to fix it.” Now buy the PSE and make a great return on your investment.

On a personal note, my stock-trading seminar is scheduled for March 3 in Cebu. I will discuss trading techniques, stock selection, and simple, practical technical analysis. E-mail me at john@mangunonmarkets.com and I will keep you informed.




E-mail to mangun@gmail.com and Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by CitisecOnline.com Inc.

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