BSP favoring a weak peso: too much faith on fiat?

Posted on June 13, 2013

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In response to plummeting exports and rising unemployment, the Bangko Sentral ng Pilipinas (Philippine Central Bank or BSP), expressed an inclination towards having a weaker peso to remedy the below-satisfactory performance of Philippine exports.

The Bangko Sentral ng Pilipinas is seen favoring a weakening of the peso against the dollar following the double-digit decline in export receipts and the higher jobless rate posted by the country in April.

In a research report issued on Tuesday, Citigroup said an accommodative fiscal and monetary policy would likely remain while the BSP’s bias for a weak peso would persist with the bleak export outlook. In April, export receipts fell by 12.8 percent year on year compared to the 0.1 percent decline in March.

(Source: Link)

Moreover, Citigroup explains on a separate report the benefits of utilizing a weak peso in exports:

“Weak Philippine peso is a better option since it enhances price competitiveness of local agro-based products in global markets, which would bode well for local farm production and employment. Accelerated implementation of rural-based infrastructure—roads, bridges, irrigation and electrification—would address festering structural issues in the farm side,” the research said.

The predicted benefits are indeed captivating. Agricultural modernization is a growing necessity in the Philippines, a country highly dependent on crops for nourishment, most notably rice. However, such promises of prosperity must always be taken with a grain of salt. In this particular case, given the central bank’s inclination to manipulating fiat currency, the game plan should automatically branded as highly suspicious. After all, forced currency devaluation to initiate an economic boom is a good example of a double-edged sword; devaluation entails potentially dangerous inflation which can stifle the internal economy. What’s more, this phenomenon is well-documented. Just ask our good neighbor China. Quoting from an article in my past blog:

China has made quite a name for itself these past few years by coming up with some sort of an economic “miracle”; from being in shambles during the end of Mao Zedong’s Cultural Revolution (which also ended the reign of Chinese communism), China rose from the ashes and became one of the most promising economies to date, providing the world with cheap products by maximizing its export industry. Almost every individual in the world has handled or used at least one Chinese product; this is how influential China has become.

However, despite China wooing the world with its staggering volume of exports, several economists are highly skeptical regarding the sustainability of China’s major economic boom. Some of them speculated that it’s only a matter of time before this boom turns against the Chinese people, immersing them in an economic slump for an indefinite amount of time. For a while these pessimistic remarks generally went unnoticed as the world continued to shower praise on China for bringing itself back on track, and even managing to surpass the performance of most export-oriented countries.

Unfortunately, the economists’ doubts about China weren’t without merit. In fact, in all probability, they nailed it, because China is currently finding itself in a tough situation; something that can sabotage the rapidly rising Chinese economy; the cooling of its housing market.

(Source: Link)

China’s recent, miraculous economic boom yielded an unintended consequence: prosperity in one economic sector meant the impoverishment of another. In this case, for China to achieve record-high export rates, the property market took one massive blow for the team. How exactly did this happen? As I mentioned before, currency devaluation results to inflation. And inflation has everything to do with this particular crisis of China’s in the past.

China has indeed produced an impressive economic boom for the world to enjoy. However, this doesn’t automatically mean prosperity for the locals. In fact, as recent events demonstrated, the “miracle” of China is slowly proving itself to be a “curse” for the Chinese people.

This is because of the inevitable consequence of currency devaluation. Since the yuan is cheaper than before, it would require more yuan to purchase stuff in China. Therefore, the Chinese actually had less purchasing power in the onset of the boom, and now need more bills to cope up with the devaluation. In effect, China has triggered its own inflation. But then, not only Chinese consumers are affected.

Real estate developers are affected as well. And since the housing market of China is relatively new, its far more susceptible to economic imbalances than the other markets. Developers, faced with less valuable yuan, had to raise their prices to cope up with the expenses. The purchasing power of the Chinese consumer went down, while the young housing market prices went up; the worst of both worlds, all in the name of the Chinese boom.

Needless to say, people cut back on buying houses. At the same time, real estate developers are going nuts because nobody’s buying their products. This brings us back to the current situation at China. The government is forcing the developers to cut down prices in hopes of winning customers back; however, developers are also afraid of incurring losses, so some of them are adamant in keeping prices high, while some of them actually increase their interest rates. The dollars received from exporting yield less value than the value of the products exported; China is selling at a loss.

To add insult to injury, it would seem that the foreigners take the bacon for the Chinese boom, while the locals take the trash. The importers had more products to choose from, and at a very cheap price to boot, while the locals have to deal with low income and high prices. This is nothing short of a tragedy.

Here we stand witness to a roller-coaster of economic mess-ups of China, which, ironically, seems to stem from the boom that made it the talk of the town in the first place. At least we know something; in all likelihood, the Chinese government holds the blame for this colossal mess.

China’s economic boom stabbed them in the back. It was the foreigners who actually enjoyed the benefits of China’s efforts, and not the Chinese themselves, which is, quite simply, ironic. Sure, devalued currency made exports a lot more affordable, to the joy of foreign importers. However, this meant higher prices in the local market. In the case of China, the then infantile property market suffered the most, since people cut back on spending in response to the inflation directly caused by the export boom. Couple that with real estate developers being forced to raise the prices of their houses to compensate for the devalued yuan, and you have a recipe for an internal economy disaster.

What’s alarming is that, given the current direction of BSP’s monetary policy, it would seem that we as an economy are headed towards the direction China took; an export boom caused by devalued currency. And history tells us what happened to China after that.

Sure, gains from export booms can be directly channeled towards the economic sectors of choice, as the research from Citigroup states. However, you don’t really create wealth by artificially devaluing your money. If, in the past, a dollar is required to buy a mug of beer, and that a dollar from the past is equal to four dollars of today in terms of real value, it doesn’t mean you can buy four mugs of beer with a dollar. It means you need four dollars to buy a mug of beer. In essence, devaluation yields an inflation, not wealth. And since consumers respond to inflation by cutting back on their spending habits, an economic sector or two must take the blow from that, just like what happened to China’s property market. It’s just how it works. In this kind of setup, a gain of an economic sector is the loss of another. Wealth creation did not really take place; only a shift in resources. And in the case of China, people suffered from that shift.

I stand by my belief that currency devaluation isn’t really the best way to go in addressing economic ills, as history has shown us. If we are dead set on reviving our stunted agricultural sector, our efforts must be aimed towards things that can actually create wealth; scientific research that can improve the quality of agricultural crops while using less resources from the environment, discovering more efficient methods of agriculture to yield maximum output, and attracting investments that can fund such endeavors or even directly participate in them. The broken window fallacy is an enduring misconception in today’s economies. If we are to talk about long-term benefits, I believe that BSP, together with the other government institutions, should look way beyond monetary and fiscal policies and discuss more about creating a playing field that is conducive to investments, which create actual wealth for the good of society.

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