• The exchange rate death zone

    Ben D. Kritz

    Ben D. Kritz

    LAST Friday, the last day of July, the peso closed at 45.74 to $1, the lowest close in five years. Although the local currency appreciated by a modest 0.2 percent through the first five months of the year, through June and July the peso has tumbled more than 2.4 percent.

    For the year through July 31, the peso has lost about 2.3 percent of its value against the dollar.

    The peso-dollar exchange rate, usually no more than a footnote to the daily business news, has attracted more attention lately because of its sudden volatility. The attention is not unwarranted, because in general, currency markets are much more sensitive than stock or bond markets. Individual transactions in the currency market are many times larger on average so that very small percentage changes represent very large amounts of money.

    While attention is warranted, alarm probably is not—at least not yet. The drop in the peso is almost entirely due to the dollar’s gaining strength, rather than some trigger in the domestic economy. As long as the Philippine economy does not slow dramatically in the next quarter or two, the slide should reverse itself relatively soon; there are natural limits on how far in either direction the dollar can drive the peso.

    Another factor we can take some comfort in is that the BSP and many market participants (i.e., Philippine banks) saw this coming. At the beginning of the year, peso-dollar forecasts for this year ranged from P44 to $1 to P46 to $1, with most favoring the upper end of that range; those predictions have turned out to be surprisingly accurate.

    A falling peso is a boon to exporters and remittance recipients, at least up to a point, because it increases the peso value of the output; after all, wages are not paid in dollars, nor do Filipino consumers and businesses use them to pay for domestic goods and services. But of course the downside is, as the money supply grows, so does inflation. That the drop in the peso happened to correspond with a drop in inflation was a stroke of pure luck – it will allow the country a little more time to wring some benefits out of the prevailing circumstances.

    Doing that is risky, however, like climbing into the ‘death zone’ on one of the world’s highest peaks—that altitude above 8,000 meters where there is not enough oxygen to support human life—with proper preparation and good weather, a fit person can function successfully in that environment for a short period of time, but is literally dying all the while. One misstep or bad decision, one unlucky break in the weather is all it takes to make for a very grim outcome.

    In the financial system, oxygen is probably not a problem, but inflation is. A declining peso puts upward pressure on inflation, which erodes the premium the exchange rate adds to remittances and export receipts. Managing the money supply to maintain the balance to the positive side can only go on for so long before the currency market finds its equilibrium, and the advantages are lost; the window of time in which the BSP can see that point approaching and react to it appropriately through market intervention, or adjustment of monetary policy through interest rates and bank reserve requirements, may be very small.

    And that is, if there is no significant change in current economic trends, no sharp external shock like a jump in oil prices or a sharper contraction in the Chinese economy.

    The consequences of that, or of the BSP simply failing to go back down the mountain and get some air at the right time are higher inflation growing at a rate that is probably a little faster than the central bank can control through its normal monetary tools, lower consumption, and a bigger negative trade gap.

    The BSP, however, is confident it has things under control, and that certainly seems to be the case at the moment. But we are in a very dangerous place, where things can go wrong even if we do everything right.



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    1. F__k this yellow tard abnoy government.. Lousy, dull , incompetent and the worst President of the Philippines ever had. Hindi na marunong mahiya, palibhasa moronic person.

    2. Amnata Pundit on

      Interesting viewpoints. Allow this struggling autodidact to share some viewpoints he picked up along the way: Alan Greenspan said in an interview recently that the rise of the dollar can be attributed to either a strong US economy, which he doubts, or a weakening world economy which he tends to believe, so I suggest we all take note of the signs of a weakening Philippine economy that are popping up in some places unrecognized. Many experts have shown empirically that a rise in money supply does not automatically produce inflation, and Japan next to America, is the best proof of this. They have been trying through endless money-printing to raise inflation to fight deflation but so far they have failed, so they announced that they will try again by printing some more. Money supply will increase if the banks lend out all their surplus and that can produce real inflation, but our banks park their extra money with the Central bank to earn risk-free interest so no real inflation can happen . Nominal inflation will happen though if the peso falls some more, but real inflation is the real problem- nominal inflation is only a political problem at worst- while hyper inflation is what everybody should fear. We are far from the latter compared to Japan Europe and the US, but with the so called domino effect we can’t be too sure how far we really are. To put inflation in proper context, since 1913 when the US FED was created- back then the US was not yet the world’s leading superpower, there were Britain, Germany, Russia and the then rising Japan -the dollar has lost 98% of it real value ! The point is normal inflation should not be treated as a problem (it is a problem as it reflects inequitable wealth distribution but that is another subject altogether) because it is merely a sign that the economy in a free market way is adjusting to yet unrecognized imbalances. It becomes a problem when the state intervenes too much in these natural market forces, thats why I say let the Peso find its true level because who knows, we might end up as the world’s only superpower like the US, provided of course we get rid of these chimps of the yellow tribe now running the government.

      • Amnata Pundit on

        I forgot to add that in Japan and the US, all that printed money has been channeled to the stock market and thats the reason these markets are at an all time high. In short, the inflation is happening in the stock market and not in the real economy.

    3. The fact is that the US dollar has been strengthening against just about all other currencies due to the relative buoyancy of the US economy (while China and much of Europe have been tanking), and the expected increase in the Fed’s lending rate. The peso is not alone in experiencing downward pressure against the US dollar. But it may have appreciated against other major currencies such as the euro.

    4. The exchange rate will go to P50:US1 in February. Right now their is an imbalance in the exchange rate of the peso against different countries.

    5. I figured the world was watching the Philippines infrastructure being destroyed the past 5 years and has calculated how that will effect the economy.
      Just about everything needs a massive overhaul or needs to be torn down and started over.
      The Prison system, the Education system, the electric power shortages, the water shortages, the airports, the mass transit system, the corrupt government.