Need to Craft new Bank Secrecy Law

There is a lot of interest these days on the issue of Bank Secrecy – specifically about looking at officials’ bank accounts to determine if they have some undeclared wealth. Some people have proposed that the Bank Secrecy Law be changed. I agree. But it is important to note that any new law will only apply to subsequent cases, and not to the current impeachment trial.

There are actually two Bank Secrecy Laws: the Foreign Currency Deposit Act (FCDA), otherwise known as Republic Act No. 6426, enacted in 1974; and the Bank Secrecy Law (Republic Act No. 1405) enacted in 1955. Both  need to be amended, or rather replaced by a new law. The new law is needed in order to fight corruption, tax evasion, money laundering etc, while protecting the privacy of bank accounts.

Why Secrecy/Privacy?
The law should be changed, and it should properly be renamed as a ‘Bank Privacy Law’. The basic principle of this law would be that a person’s bank account is private – i.e. known only by him and his bank. But that the government should have the capacity to access what it needs from such accounts to determine if any laws have been violated. Privacy should not provide a safe haven for those doing illegal acts. At the same time, privacy should be respected even when a person’s bank account records are accessed.

People want to have privacy in their bank accounts for all kinds of reasons. Bank accounts reflect what one does in life, and these things do not need to be known by the public. They may have special reasons why they do not want to divulge their bank account data.  Things like: donations to one’s church and other charitable causes, tuition fee payments, even the cost of a house may not be good to divulge. And there are things that are legal, but may be awkward: payment for a drug rehab treatment, a VD clinic, or even informal support payments for an ‘undeclared’ child.

Public officials should be subject to more monitoring than the rest of the public. This is to check against cases of corruption. They are required to file SALNs (Statement of Assets, Liabilities and Net worth), which naturally include their bank account balance. In order to ensure that SALNs are accurate, anti-corruption bodies should be able to verify that their declared bank account balances are accurate.

The question that policymakers should consider is: how to craft a law that protects people’s bank privacy, while ensuring that tax evaders, criminals and corrupt officials don’t use the banking system to hide their deeds?

Provisions
Some provisions of the proposed law would be:
Protection of Account Privacy. Bank accounts, whether they are in peso or in foreign currency are private. Anybody violating this without legal justification will be severely punished. When an investigation makes it necessary for a Court to access some account data, the data should be limited to what is strictly needed, and the full account record should never come out in a court record.

End of Year Balance. At the end of every year, banks will provide depositors a statement of their balance as of 31 December, as well as the amount of tax withheld. This will be used as a basis for SALNs etc.

Withheld Tax. All Earnings through the banks will have tax withheld automatically. This tax will be turned over to the tax authorities. Tax on interest for foreign currency accounts will also be collected; the rate of tax will depend on the declared citizenship of the depositor. If an account holder’s country does not collect tax on interest earned, tax will be withheld based on Philippine law and collected by Philippine tax authorities.

Tax authorities can request from banks an end of year statement for persons they are investigating, which specify: total deposits, total withdrawals, total tax withheld.

Ombudsman and Sandiganbayan (anti-corruption court) have the right to request End of the Year balance, total deposits, total withdrawal and tax withheld for any official that they are investigating.  If, upon investigation of these documents, the Sandiganbayan deems it necessary, it can also ask to look at that official’s monthly bank statements.

Anti-money laundering. The NBI should be able to get access to an account in terms of the money transfers into or going outside the country, as well as large deposits and withdrawals (perhaps  amounts of P1 million or more).  The bank will provide these to them in a special form, without revealing the account holder’s other bank transactions.

Prosecution of Criminals. Courts should be able to access bank records of people being tried for financial crimes (including tax evasion and money laundering). But these records remain private – meaning that only the judge (and some select court officials) would have (temporary) access to the full records. On the basis of their examination of the actual records, they would sign an ‘extract’ from the records – which would omit all transactions not relevant to the case – as correctly reflecting the actual record. It will only be these extracts which will appear in the court record. The original records will be returned to the bank.

Bank Officials. Since bank officials have a key role in keeping bank accounts private, they have a big responsibility in their hands. Any violation of the rules by bank officials (e.g. leaking the contents of an account) should be severely punished. Before they are entrusted with these responsibilities, bank officials should be cleared by both the NBI and the BSP. The BSP will hold a regular audit of cases where bank balance data are shared with courts, to ensure that bank officials and courts correctly follow the procedures.

Exodus?
Some people are concerned that there would be an exodus of funds from Foreign Currency Deposits if the Bank Secrecy Laws are amended. I think that the economic effect of such new laws will be limited. It may even be beneficial, since it may result in a devaluation of the peso, which would benefit exporters and OFW families.

The main effect of new Bank Secrecy Laws will be that it would be increasingly difficult to hide ill-gotten wealth in the banking system. And this may, or it may not, lessen corruption of officials. If, in the process of doing so, we also rid the country of its reputation as a haven for tax cheats and money-launderers, then that should be all right.

Shift Reserves Away from US Treasuries

The Bangko Sentral ng Pilipinas (BSP) has said that it was considering shifting some of the Philippines’ Gross International Reserves (GIR) from US Treasuries. I think it should. It is high time that the Philippines stops relying on the US dollar as the sole reservoir for our hard-earned money.

Liquidity
HSBC objects to the BSP plan, and advises the BSP to stick to using US Treasuries exclusively. It says that US Treasuries are the most liquid. But the question that we should ask is: How liquid should the Philippines’ reserves be? If we shift from US Treasuries to German bonds, will we then be holding instruments that we can’t sell right away? I doubt that – German, Dutch, Norwegen, Australian bonds (which all have AAA status, unlike US Treasuries) are liquid enough. We can sell them in a matter of days and at a good price – there are enough of those bonds going around for that. Perhaps not ‘instantaneously” like US Treasuries. But we don’t need instruments to be THAT liquid.

One other thing about liquidity is that it is a function of how much a country borrows. Because the US, Japan and Italy are the world’s biggest borrowers, that is why their bonds are the most plentiful, and thus the most liquid. But they are not necessarily the best places to put our money.

Reserve Value
Reserves should be able to keep their value with time, or even appreciate.  It would be prudent, even imperative, to keep our money out of instruments that we expect to lose value.

US Treasuries, like all bonds,  lose value as their interest rates rise. Now, the interest rate on Treasuries are at a very low point – 10 Year Treasuries are at 2.3%.  If the interest rate were to rise – as it should – the Philippines would lose money holding them.

And then we also need to consider the deteriorating value of the US Dollar. The Philippine peso is now trading at 42:1 to the dollar. A couple of years ago, it was 44:1.  We lose money by keeping dollars in our reserves. But if we had stored the reserves in Yen or in Euro, the value would have remained the same (in terms of pesos) or even appreciated.  The dollar is bound to lose value in the future, and we would be throwing away our money if we were to put all of our reserves into it.

Major Trading Partners
One of the principles in keeping international reserves is to keep them roughly based on a country’s trading partners.  On this basis, the Philippines should indeed diversify away from US treasuries.  If we look at the Philippines’ trading partners for 2010 we can see that China is our number one trading partner (17.3%), followed by Japan at 14.6% of trade. The US is only our third trading partner, at 12.3%.   Based on this, it would be logical to keep more Yuan and Yen in our reserves than dollars.

The Department of Finance seems to be saying that it has diversified our Gross International Reserves away from US dollars. But they do not say what percentage of the GIR remains in US Treasuries. If they truly have diversified, the GIR should be less than 50% in US dollars by now.

QE2: A Formula for Disaster

The US Fed will soon decide whether to embark on a program of quantitative easing (QE2), which will mean that it will pump from $500 billion to $2 trillion dollars into the US economy, in the hope of stimulating it. This will be the second time in the recent past that it will do so.  In 2008, the Fed “created” $1.7 trillion, and used this to buy mortgage-bound securities, which nobody wanted to buy, and get the economy moving again. Now, with the economy growing at 2% and with 10% unemployment; the Fed wants to use quantitative easing again, in order to induce the economy to grow faster, and to lower the unemployment rate.

I think this is simply a recipe for disaster. In the first place, the “bubble” which burst in 2007 was caused by excessive spending, especially in the housing market. Now, the Fed wants to address the ensuing low growth by pouring money into the system. It sounds like the saying: “avoid hangover, stay drunk.”

US Centered
The Fed is playing with the idea of quantitative easing (QE2) because, for them, QE2 will stimulate the economy, and there would be minimal bad effects.  But this is because they only look at the short-term situation of the American economy. They do not realize, for one, that QE2 will have a detrimental effect on the US Dollar’s reputation the world over. They assume that the dollar’s prestige and acceptability all over the world will be the same even after QE2.

I think that this all depends. If QE2 is limited to say $500 billion, perhaps it may not have that much of a detrimental effect on the dollar’s prestige (though it is really going to be at the edge, I think). But if QE2 will be $2 trillion, then I am almost sure that there will be a chain reaction in the world that will turn around to bite the US back.

The US Dollar’s prestige throughout the world is declining, and since it is not an “ordinary” currency (but rather the world’s reserve currency) it needs to maintain a minimum of prestige and value for it to continue in its present role. That the dollar will remain as the world’s reserve currency is not a given; and I think that printing too much additional dollars will severely damage the image of the dollar.  And if this image is severely damaged, think of the consequences: what if the Saudi’s suddenly decide to take their currency off its US Dollar peg? What if this would lead to a substantial increase in the dollar price of oil? And what if the Chinese decide to get rid of their own US Dollar peg? These events are not theoretical; I’m sure the concerned governments are seriously thinking about it.

Money created through quantitative easing does not remain in the US. Hedge funds use this to buy fixed-interest assets in other countries, causing those countries’ currencies to rise in relation to the US dollar. And this will force these countries, sooner or later, to raise the dollar price of their exports, just to be able to maintain their profits. This will in turn mean that imported products in the US will cost more.

Even for the US
But even for the US, QE2 at this moment will be quite ineffective to stir the economy, and at worst will even cause more trouble. QE2 will increase the supply of money, but this will not do too much in the way of solving the problems with the housing sector. Increasing the money supply will not save people’s homes from foreclosure; and thus could not solve the problem of low consumer demand. People don’t spend as much because they fear they may lose their jobs or the houses, and I don’t see how pumping money into the economy will help this.

Sure, economic theory says that additional money supply could stimulate the economy, even the housing market. But this is true in a “normal” situation. Additional money, when provided at a time when banks are willing to lend, and when there is sufficient consumer demand (or industries are busy investing and hiring), will mean that the economy will grow faster than it otherwise will. But consumer demand and industrial investment will not happen just because there is money available; consumers and businesses should have at least a minimal level of confidence before they increase their expenses. This is like pulling a horse so that it is next to the river; nothing you could do could compel that horse to drink. If it is thirsty, it will drink. If not, there is no way that you can force it to drink.

But worse than being ineffective, QE2 could also do harm. For one, it creates an oversupply of bonds, which are fixed-interest instruments. This translates to low interest rates, which has a detrimental effect on pension funds and insurance companies. It also creates an artificial boom in the prices of stocks and even commodities.  The artificial boom in stocks will lead eventually to another stock market crash. And the rise in the price of commodities will mean higher consumer prices for the people.

QE2, by increasing the money supply, and through the mechanism of “carry on” trade (where people borrow cheaply in the US, and invest the money in fixed-interest instruments in other countries, taking advantage of the interest deferential, and possible foreign exchange gains) will devalue the US dollar. And this devaluation, some economic theorists say, will increase exports and decrease imports. True, it will. But it takes 18 months for exporters to gear up, and importers to adjust their purchases downwards. In the meantime, the balance of trade will worsen because exports remain the same, while the price of imports rise. And, in this world today, an 18-month gap is a long time; long enough to cause a downward spiral in the economy.

The inflation that the Fed wants to induce will come. The problem is that I don’t see how the Fed will be able to stop it when it comes. I don’t think that inflation will simply stop rising where the Fed wants it to. It will continue rising. And, if it is accompanied by low growth, that inflation will not be easy to eradicate. It will have become stagflation.

If the Fed realizes the full implications of quantitative easing on the US and world economy, I think they would think twice about using this instrument. Then, it will be the case of limited positive effect against a very dire possible negative effect.

The Fed would be well advised NOT to use quantitative easing at this time. Let the US economy grow at 2%. While this is low, it is a good basis for the economy to build on to achieve higher growth rates later. The US economy had been on a spending binge; let it recover gradually.

Peso will appreciate after May elections

The way things are going now, it seems that the peso is set to continue its upward trend even after the May elections in the Philippines. Why?

Remittances
Remittances again. May-June is peak time for remittances, especially for school expenses, so the peso is sure to gain from this. Add to this the government plans to float $500 million of bonds especially for OFWs, partly to cover the budget deficit. This is an additional $500 million that will be “remitted” at this time.

Elections
No matter who wins in the presidential race, the vice-presidential race seems to have been won already by Mar Roxas, who is viewed internationally as the most business-friendly vice-presidential bet. And Noynoy Aquino and Villar are both perceived to be business-friendly. Foreign investors now though would be holding back on the off-chance of an Erap Estrada or Richard Gordon victory, who almost promise to get the government deficit to skyrocket.

After the elections, foreign investors will be more confident in the Philippine economy and will increase their investments.

Carry over
The prospect of an appreciating peso feeds on itself. With the improving world economy and the end of the Greek financial crisis, the dollar is set to decline against most of the world’s currencies. This,  in turn will push speculators to place investments where it pays more in interest than the US (the Philippines is one of those places). This will show in an increase in “portfolio investments” by foreigners. Which will help to strengthen the peso, and make the effective interest rate differential even bigger, pushing the peso ever stronger.

Another effect is the retention of dollars by foreign companies in the Philippines. If the peso is perceived to be strengthening, foreign companies tend to hold on to their profits (in pesos) for as long as possible, in the hope of getting to remit them later for more dollars. This would also be a self-perpetuating trend, with more companies doing this with time, as they see that other companies are taking advantage of this trend. This, in turn strengthens the peso, etc. Of course, the companies will need to repatriate profits eventually, but they will do it at the end of the year – and cause the peso to weaken around December. But that is still a long way off.

Looking forward to 2010

I am not one to make New Year’s resolutions. So, I will just make projections of what I think will happen in the coming year.

Economic
The Philippine peso will appreciate to around PhP32:$1 by the end of the year. BPO income and remittance will be strong during the whole period, and of course, the elections will help to raise the exchange rate of the peso.

The US economy will not really recover, although it is nominally out of the recession. Unemployment will remain high.

Oil prices will exceed $100/barrel. This will be due mainly to the growth in consumption in places like China and India, but also due to production problems in some other places.

Political
Noynoy Aquino will win in the presidential elections. The CPP and its above-ground organizations will be in disarray, as a result of  internal struggles; perhaps it would split.

No climate-change deal among governments will be made during this year, inspite of valiant attempts at doing so.

Iran will have a change in government, probably into a toned-down theocracy (i.e. much more democratic). Big strides will be made in the Israeli-Palestinian peace process, but peace will not yet be attained.