Monetary Policy and Philippine Economy Part 3 - Mises' Lecture

This is my summary of Mises' lecture on inflation with some insertion of content from articles in this blog. I am using the word "inflation" here in its primary sense. You will recall that I already made a distinction in the early part of this series. This distinction is taken from Mises' lecture.

In this summary, I want to share 5 subsidiary topics under inflation: 

1. Two Ways to Solve the Financial Problems of the Government

After Mises clarified the distinction, he shared about two ways the government solves its financial problems. The legitimate way to do it is by taxing the citizens. But since taxing the people is considered not good for political career, another way of addressing the government's financial difficulties was made. This time it is by simply printing paper money.

In directly taxing the people, at least the people are aware about the deduction in their salary and they can adjust their expenses to a new financial situation brought about by new taxes. And another advantage of direct tax compared to simply printing paper money is that the price of goods and services is not affected. The only negative repercussion of such an act is the increase in buying power for the government and less on the part of private citizens. 

But this is not the case when government decides to print paper money to solve its financial trouble. It is also a tax, but people do not see it for it is done indirectly. And it also does not affect anyone's political career. 

What's detrimental in this form of indirect tax is that since people do not see any reduction in their income, they think that they can still buy the same amount of goods that they previously buy when the quantity of money is not yed increased. They do not realize that the purchasing power of their money has been reduced since the certain consequence of printing more money is price increase. And since prices of goods and services have already increased as a result of additional money, those who receive the same amount of salary when the new money was not yet introduced will suffer. And since most people do not know how their money lost its value, they simply consider it as something natural.

2. The Most Affected Sector in Inflation

The fact is, price increase and the lost of purchasing power are not natural. It is an inescapable outcome of government's act of printing money to address its financial problems. So the financial burden is transferred from the government to the citizens without them knowing it. 

Mises was questioning not how the money is spent but how the money is obtained by the government. Due to the preference of the government to use printed money rather than direct tax, some people will have greater advantage than others. Those who receive the new money earlier are in a better position than those who receive it late. Ron Paul identified the early beneficiaries as the “speculators, bureaucrats, and the special interests favored by the government” (Pillars of Prosperity, 2008, p.110). The sufferers are the laborers and savers. Among them are the teachers and ministers. Mises clearly identified teachers and ministers as the people who would suffer the greatest disadvantages from the increase in money supply. He explained why this is so: 

"As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedicated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corporations finally discovered that, after all, one should also raise the salaries of those dedicated people, the earlier losses they had suffered still remained" (Economic Policy, 1979, p.61).

Since there are groups who benefit from new printed money, for them, this kind of monetary policy is good. I think this explains why there are people who insist that there's nothing harmful about increasing the money supply. On the other hand, those who are harmed by this policy do not know the connection of the government's action to their financial situation. And besides, the technicalities surrounding this matter is so complicated, as if, it was really made intentional in the first place to hide it from average citizens. 

3. How long shall inflation last? 

The basic flaw of this kind of monetary policy is that it cannot last. The Roman Empire, Han Dynasty, and Germany are used as typical examples to demonstrate the catasthropic end of continually increasing the supply of money. Mises described the situation of Germany in 1923. He stated, "On August 1, 1914, the value of the dollar was four marks...Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks" (ibid., p.63). In short, German currency collapsed. 

The question is, until when will the government continue this monetary policy? Mises answered: "Probably as long as people are convinced that the government, sooner or later,...will stop printing money..." (ibid. pp.63-64). When people do not believe this anymore, then they will realize that prices will continue to increase. As a response, they will start "buying at any price, causing prices to go up to such heights that the monetary system breaks down" (ibid. p. 64). 

Under inflationary monetary system, becoming a debtor is considered wise. Anyone who understands the system could take advantage of it and could utilize it to attain easy wealth. Another feature of inflationary policy is the perception about the government's power. It is looked upon by the people as all-powerful. People ask the government to take care of them for with an unlimited supply of money, the government can do anything. This kind of government perception is a clear break-away from the past for then it was considered the citizens' duty to support the government, not the other way around. US President Grover Cleveland said, "While it is the duty of the citizens to support the government, it is not the duty of the government to support the citizens" (p.66).

In order to correct the wasteful spending of the government, Mises believed that only a return to the gold standard can do it. He argued that the gold standard is a form of protection from extravagant government. One great advantage of it is that "the quantity of money under the gold standard is independent of the policies of governments and political parties" (p.65). 

4. Labor Unions

After explaining the advantage of gold standard, Mises turned to the labor unions. He considered it as the second power next to the government who influence wage rates. The problem with the wage rate demanded by unions is that it is above the level of wage in free market. As a result laborers are only employed by industries prepared to suffer loss. When businesses can no longer afford losses, they shut down resulting to more unemployment.

Currency devaluation has been the usual response of governments to unemployment. But as both workers and unions realized through time that currency devaluation had reduced the purchasing power of their demanded wages, they made additional demand: wages must go up with price increase. This is known as "indexing"(p.69) and so the unions became index conscious that made currency debasement as solution to unemployment inapplicable.

5. Full Employment

John Maynard Keynes was a strong advocate of currency debasement. In his 1936 book, "General Theory of Employment, Interest and Money", he argued that unemployment is bad and that the only way to solve it is by inflating the currency. Mises described Keynes' strategy as "cheating the workers" (p.70) and this is considered necessary in order to attain full employment. 

For Mises, there is no need to resort to inflating the money supply to achieve full employment. The market should be allowed to operate freely without the interference coming from both the governments and the labor unions. This is the only way to achieve full employment. Mises explained this further:

"...wage rates for every type of labor tend to reach a point at which everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall" (pp.70-71). 

So the choice should not be between inflating the money supply or unemployment. Full employment can be achieved without increasing the money supply. 

Conclusion: 

Mises concluded his lecture by emphasizing that inflation is a monetary policy and it can be changed. And the only way to change it is for the intellectuals to do their role in shaping public opinion. Once the public are informed about the disastrous results of inflation, Mises was confident that politicians will abandon this monetary policy.


Part 1 - Dr. Nye's Lecture

Part 2 - Summaries of 6 Related Articles

Part 4 - Biblical Critique of Inflation


Source: Mises, Ludwig von. (1979). Economic Policy: Thoughts for Today and Tomorrow. Chicago: Regnery/Gateway, Inc.

Monetary Policy and the Philippine Economy Part 2 - Summaries of 6 Related Articles

As a result of my Google search last July 2, I came up with top 10 links, but after visiting them all, I selected seven. The first link directed me to Dr. Nye's lecture. At this point, I want to share my summaries of the content of the remaining 6 articles.

Among six articles, three are safe; two are more realistic, and; the remaining one is in between. That lone article reminds me of Dr. Nye's lecture except that part where he mentioned that Philippine economy was protected from trouble due to non-engagement.

1. Safe Articles

Vulnerable but the economic fundamentals are sound

The recent shift in macroeconomics due to the announcement made by the Chairman of the Federal Reserve exposed the vulnerability of emerging markets. Gerardo P. Sicat claimed that though the Philippines' vulnerability was exposed as result of massive withdrawal of "hot money" from the PSE, our economic fundamentals remain intact. I think he was happy to see peso depreciation for this would benefit the export industry. However, the reduction of stock price index is bad news for domestic investors.

I just wonder why Sicat was calling for reform if the nation's fundamentals are really sound? What did he mean by reform? We read such need of reform from Dr. Nye's lecture. Do they mean the same thing or is Sicat's idea of reform one of protectionism? If he was referring to protectionism, I cannot understand how come he also advocates economic liberalization, which in fact is something commendable.

Time is so fast

Lilian Karunungan's article from Bloomberg reminds me of PSE's jubilant celebration in 2012. The peso appreciated and also there were videos that circulated around that time claiming that the Philippine economy was positioned for growth for decades. But the celebration was short-lived. After nine months, we witnessed that the so-called growth was nothing but an outcome of temporary parking of "hot money" escaping the impact of American QEs.

Bubbles - Fear and Denial

This time, its the impact of Japan's QE on Asia's economy. Policy makers in Asia were afraid, but the Governor of Bank of Japan considered their action as insignificant. The Governor of the Philippine Central Bank confirmed this. And besides, Kuroda promised to monitor the impact of their monetary policy. The writers mentioned also that other central banks have been doing the same thing such as the Federal Reserve, the Bank of England, and the European Central Bank, as if, by mentioning them, the fear of policy makers in emerging countries is baseless after all.

2. More realistic articles

Danger Zone

After defining QE, Cassandra Ty mentioned that US, UK, and Japan have all adopted this monetary policy. The goal of QE is to stimulate the economy. However, since the economy of the world is interconnected, the consequences of this action cannot be confined within the boundary of the initiating nation. Ty clearly identified that it "would have a spillover effect on the rest of the world" and that in fact a huge quantity of this new created money went into the Philippine stock market. Aside from possible currency war in the future, she saw other dangers of QEs include trade imbalance, inflation, and asset bubble.

Till death do us part

I consider this article from Business Mirror most realistic among the six. The writer mentioned about the IMF-WB annual meeting attended by the members of the Philippine Department of Finance. And then he confidently claimed that the Philippine government is "absolutely clueless" about the nature of global crisis and predicted a dark legacy for the existing administration as one of "economic disaster" unless policy makers would start to understand the situation and make necessary changes.

The writer is highly critical of QE. After mentioning the differences in the responses of Thailand, EU, South Korea, and US to a difficult economic situation, he raised the question about the source of $5 trillion, which the US needs to have a good start. He seemed to imply that through QE, the US could get such amount from the emerging countries.

And then the writer quoted history as his basis that monetary systems using fiat currency all collapsed. He cited the experiences of Roman Empire and China's Han dynasty as his examples. In the end, he issued a warning that unless the Philippine peso will be allowed to appreciate, our economy will crash together with the continuous devaluation of the US dollar.

3. In between article - From unreliable PSE into real economy

"The biggest percentage loss since the Great Recession of 2008 and the biggest points dip in the institution's history", that's how Heydarian described the recent drop in PSE prices. He added that emerging markets "have been under siege" as a result of anticipated QE retreat. So the trend is changing in favor of central economies like US and Japan and against emerging economies such as the Philippines. So the call now is for the reform of economic policy and shift the attention from PSE into the real economy. The writer ended his article by giving credit to previous administration.

Part 1 - Dr. Nye's lecture


Part 3 - Mises' lecture


Part 4 - Biblical Critique of Inflation

Monetary Policy and the Philippine Economy - Dr. John V. C. Nye's Lecture

I am done reading Mises' 4th lecture, inflation, from the book "Economic Policy: Thoughts for Today and Tomorrow". Now, I want to write my own piece combining:

• Dr. Nye's lecture on quantitative easing, 
• Summaries of 6 related articles, 
• Mises' lecture, and 
• Biblical critique of inflation

But before I do that, I want to share first my understanding of three important terms.

Three Important Terms

I accept the technical difference between inflation and quantitative easing. However, I see them as basically similar for they are both monetary policies and their essence is the increase of money supply.

Inflation has two meanings, the primary and secondary. Its primary meaning is historical. The secondary meaning is popular. Its historical meaning is either an increase in money supply or it includes the act of creating new money, which results into the reduction of the purchasing power of the monetary unit and price increase. The popular meaning is simply confined in price increase.

Considering the primary meaning of inflation, quantitative easing is basically referring to one and the same monetary policy. Mises Wiki helps me clarify the confusion in my mind when it defines quantitative easing as "a euphemism for an inflationary strategy of monetary policy pursued by central banks." So the term is actually a vague substitution for something that is considered harsh, and in this case, the act that is considered harsh is the increase in money supply.

Concerning monetary policy, I restated the definition given by Mises Wiki as the manipulation of money supply advocated by both monetarists and Keynesians through central banks to maintain economic growth and limit unemployment. Only the Austrian school criticizes monetary policy for its destructive results such as the redistribution of wealth, business cycle, and other disastrous economic distortions.

After providing the definitions of the above terms, allow me to proceed to Dr. John V. C. Nye's lecture.

Dr. Nye's Lecture

Dr. Nye gave this lecture in January 14, 2011 and it was attended by "BSP officials and representatives from both the public and private sector, e.g., the Senate, the Bureau of Treasury, the Presidential Management Staff, Bankers Association of the Philippines, Chamber of Thrift Banks, Philippine Economic Society, Ayala Life, Citigroup, USAID, IMF, and members of the Press." The title of his lecture is "Why Quantitative Easing was good and should be better...and how the Philippines should benefit from it."

The academic credentials of Dr. Nye is very impressive. He earned his Ph. D. in Economics from Northwestern University. At present, he is "a Professor of Economics at George Mason University and holds the Frederic Bastiat Chair in Political Economy at the Mercatus Center." He is also "a specialist in economic history..." Interestingly, the problem of economic development in the Philippines is included among his existing numerous projects. 

In presenting Dr. Nye's lecture, I would like to reverse the order by enumerating first the problems and solution he identified in Philippine economy before presenting his positive assessment of quantitative easing.

1. The Problems in Philippine Economy

At the outset, he described the Philippines as "bystanders in the global drama of economic maneuvers" (p.8) and this explains why we are not much affected by global economic crisis. In short, we are not really in the game; we are just watching as the global players battle on the ground. So it is not really true that the fundamentals of Philippine economy is sound that's why we do not suffer as other countries do. Dr. Nye described further the Philippine situation as "non-engagement" (p.9) and lacking in integration with regional and world trade. So the outcome of such position will be protection from trouble and at the same time, from wealth. 

Dr. Nye painted the ugliness of the nation's economic situation. He described the country as the exact opposite of China, which has become "more economically liberal and more business friendly..." (ibid.). The other way of saying it, is that the country is hostile to business initiatives and you can see it through interventionist policies.

Dr. Nye identified numerous problems in the economy, which are "mostly self-imposed" (p.8). In his view, even though the Philippines share some of these problems with neighboring countries, our situation is far more serious. And that's why he thinks that the country has "one of the most distressing climates for investment in the region" (p.10). 

Though there are other problematic areas in the economy like unprepared infrastructure for regional expansion and excesive concentration of industry in the NCR, most descriptions of the nation's economic problems are related to policies and regulations. Below are the descriptions of economic problems that Dr. Nye identified: 

• "...bad policy and excessive regulation is a breeding ground for corruption and inefficiency that further damages the economy, producing cynicism and complacency" (p.10). 

• "The PH has a fragmented and poorly integrated economy marked by a dysfunctional state institutions coupled with excessive intervention and regulation" (ibid.). 

• "Current rules also slow down the development of more advanced urban regions to accept workers who would like to move out of the countryside" (ibid.). 

• "...while industry is somewhat productive, it is inefficient and hampered in its further development by excessive regulation and high transaction costs" (ibid.). 

• "Nationalistic rules on ownership and investment limit competition and entrench special interests" (ibid.). 

• "...among these are the constitutional restrictions on foreign ownership and investment in the Philippines coupled to the mix of bureaucratic red tape, complicated taxes, and petty corruption..." (p.11). 

• "A crazy patchwork of subsidies, price controls, and regulations give the illusion of helping the poor, while effectively stiffling the economic progress and enriching the corrupt and the politically well connected" (ibid.). 

• "So many policies in the Philippines seem to be motivated by a nationalism that says it is better to be protectionist and nationalistic even if the end result is greater emigration and lower growth" (ibid.). 

• "Various reciprocity and tax rules have had the effect of driving foreign air carriers away from the PH thus weakening competition and taxing PH travelers, PH business, and incoming tourists. Taxing foreign businesses with outside options does not harm the foreigners but ourselves" (ibid.).

Dr. Nye summarized our nation's problems in one sentence: 

"PH major problems have less to do with macroeconomic or fiscal stability but with a badly distorted micro-economic price situation, poor and unreliable property rights and contracting, a stiflingly legalistic bureaucracy, a slew of policies and institutional constraints that are anti-investment and anti-competitive, and a political economy that favors the worst mix of populism, elite rent-seeking, and high-minded but unproductive nationalism" (p.13).

2. Solution to Philippine Situation 

Philippine situation is not at all hopeless. It is not yet too late for the country to benefit from what is happening right now in global economy. After reading the entire lecture, I discern that Dr. Nye's proposal though taking into consideration his idea that the country can take advantage of quantitative easing, he believed that the real issue lies in reforming "micro-economic policies to make investment more competitive." (p.8). In order to maximize the benefit of what's going on, the Philippines must act faster than its neighboring countries in reforming its regulations if it does not want to be ignored by foreign investors due to the existence of better options. Moreover, investors must be given the assurance that the changes in policies will stay and remain consistent in the future. If these conditions are not met, our country will once again "look back in a few decades at another set of missed opportunities as the gap with our Asian cousin further widens" (p.13).

3. Positive Assessment of Quantitative Easing

I observe that even Dr. Nye is against interventionism, his monetary ideas are far from the Austrian school and reflect the perspective of Milton Friedman. We can see this in his assessment of the causes of the 2008 crisis, Quantitative Easing, the Federal Reserve, the Great Depression in the 1930s, US economic recovery, and inflation.

Dr. Nye recognized three separate causes of the 2008 global crisis. He did not see the prior increase in the money supply as the primary cause of the crisis. In fact, for him, the greatest mistake of the chairman of Federal Reserve was the hesitation to provide bigger dosage of quantitative easing. He believed that inadequacy of "monetary expansion can make a bad economy much, much worse" (p.1) and "...real crises can be created or worsened by inadequate monetary policy" (p.2). He was actually proposing "...more easing and something that would surpass what had already been tried" (p.3). He is convinced that "...all the evidence is that QE2 was helpful not harmful but that it was inadequate and will require still more intervention" (p.6). Furthermore, he thinks "...that the Fed still has many effective instruments at its disposal..." (ibid.).

The monetary view of Dr. Nye is consistent to Friedmanian analysis of the Great Depression in the 1930's. The major problem then was insufficient liquidity. And also in his view, "...the only policy in the 1930s that helped the recovery was Roosevelt's abandonment of the Gold Standard in 1934" (p.4).

Moreover, for Dr. Nye, US economy has already experienced "notable recovery". He based his idea of recovery on the improved performance of the stock market, rising price levels, and higher GDP.

And finally, his assessment of inflation is also contrary to Austrian analysis. He does not like high inflation, but considers low inflation as an "evidence that we need more not less monetary expansion" (p.6).

4. Personal Comment

Dr. Ron Paul, schooled in Austrian school, diasgrees with Dr. Nye's monetary view. Dr. Nye's interpretation as to the three separate causes of 2008 crisis ignores the critical role of the Fed. For him, the real estate bubble, banking crisis, and macroeconomic collapse had no connection with each other and he failed to see their connection to the action of the Federal Reserve.

In Dr. Paul's congressional report, “The U. S. Dollar and the World Economy” dated September 6, 2001, he argued that the Fed has the primary responsibility for the 2008 crisis and real estate bubble in particular. According to him, it all started with Federal Reserve credit expansion to the tune of $3.2 trillion (Pillars of Prosperity, 2008, p.219). Here is my summary of that connection:

"It all started with Federal Reserve credit expansion. Huge size of the credit went into real estate, stirred up by the '$3.2 trillion of debt maintained by the GSEs' (p. 219). The GSEs by the way, was composed of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. The GSEs received a special treatment through low interest rates and the Federal Reserve monetizing them 'just as if they were U. S. Treasury bills' (p. 220). This action of the Federal Reserve sent an attractive message to foreign central banks causing these banks to purchase great quantity of GSEs."

Ron Paul also contradicted Dr. Nye's idea about quantitative easing. In September 14, 2012, Dr. Paul asserts, “Any further quantitative easing from the Fed, in whatever form, will only make our next economic crash that much more serious.”

These are just two examples where Ron Paul as representative of the Austrian school differed from Dr. Nye's monetary perspective.

However, regardless of Dr. Nye's positive assessment of quantitative easing, which Austrian economists consider erroneous, still he did not believe that quantitative easing as far as the Philippine economy is concerned would greatly benefit the country without consistent adjustment in micro-economic regulations. QE does not create growth and has little effect on local economy. For him, even increase in tax revenues is incapable to improve the economy without regulatory reforms. He saw the primary function of monetary policy as "a means to smooth out short term fluctuations and provide the proper background conditions to support development" (p.8). He added, "The purpose of monetary policy should be to allow the real economy to perform better" (ibid.).

Part 2 - Summaries of 6 Related Articles

Part 3 - Mises' Lecture

Part 4 - Biblical Critique of Inflation