Ahead of the G-7 meeting on Friday and Saturday, a Reuters article informed us that the US has issued a 'warning' to Japan not to deliberately devalue its currency. Evidently this 'warning' was meant for domestic consumption, very likely it was aimed at unions and automakers, both of which have continually complained about Japan's currency since the 1970s. Their complaints tend to become more vociferous whenever the yen is in a short term downtrend, but the reality is of course that the yen has been going up against the US dollar with nary a significant interruption since about 1950. In that sense it is quite humorous when the US warns Japan not to devalue the yen. Of course yen debasement is now the official Japanese policy – and in reality there are no differences of opinion on it so far. After all, nearly everyone is now taking part in the race to debase. Since virtually all governments continue to be mercantilistic in their outlook in spite of giving lip service to the advantages of free trade, spats about exchange rates will always be with us.
“The United States told Japan it would be watching for any sign it was manipulating its currency downward, but Tokyo said it met no resistance to its policies at a meeting of Group of Seven finance ministers which will conclude on Saturday.
As ministers and central bankers met on Friday in a stately home set in rolling countryside 40 miles outside London, differences were also evident over whether to prioritize debt-cutting or promoting economic growth.
U.S. Treasury Secretary Jack Lew said Japan had "growth issues" that needed to be dealt with, but that its attempts to stimulate its economy needed to stay within the bounds of international agreements to avoid competitive devaluations. "I'm just going to refer back to the ground rules and the fact that we've made clear that we'll keep an eye on that," Lew told the CNBC business news channel.
The yen hit a four-year low against the dollar on Friday, beyond the psychologically important 100-yen mark. It also trades at a three-year low against the euro.
The moves were driven in part by Japanese investors shifting into foreign bonds, a move that had been expected since the Bank of Japan unveiled a massive stimulus plan in January.”
Taro Aso is evidently unconcerned about the sham warning. After the G-7meeting concluded, he said:
“We explained at the G7 that Japan took bold monetary and fiscal action to end prolonged deflation, with the government and the Bank of Japan working closely together," Aso told reporters after hours of talks with fellow Group of Seven finance ministers and central bankers.
"The G7 didn't have a particular problem … I think Japan's stance is gaining broader understanding," he said.”
Given that practically the whole world is currently on this bizarre trip that prosperity can be increased or regained by means of printing money, why should Japan's mad-cap flight forward not meet with 'understanding'?
Below is a chart of the yen against the dollar since 1970 (note we use the inverse notation, i.e., a rising line means a stronger yen):
Nothing to Fear
Channeling the self-soothing proclamations of inflationists throughout history, Haruhiko Kuroda declared after the meeting that JGB yields 'won't spike'. We believe that it remains possible that the inflationary policy will fail to achieve its declared aims and will sooner or later be abandoned again, but that is of course not certain. It depends partly on the determination of the BoJ and what methods it is willing to try.
It is definitely also possible that Kuroda's policy will 'succeed', in which case yields must eventually rise – something he acknowledges. As we have pointed out several times, he cannot have everything. If consumer prices indeed begin to rise, yields below 1% for 10 year JGBs will be history. However, Kuroda apparently expects to remain in perfect control of the process. His idea seems to be that the BoJ will create precisely 2% 'CPI inflation' and that nominal government bond yields will only rise a little bit to reflect that.
“Japanese long-term interest rates should not shoot higher as a result of money flowing out of government bonds, Bank of Japan Governor Haruhiko Kuroda said on Saturday. Kuroda added, however, that it would be natural for long-term rates to rise over time if Japan meets its goal of pushing inflation up towards two percent.
He said a shift in funds from Japanese government bonds to stocks and into lending was already taking place but that the BOJ was increasing its balance of JGB holdings at an annual pace of 50 trillion yen.
"The BOJ dealt with short-term volatility in bond prices by adjusting its market operations," Kuroda told reporters after a two-day meeting of G7 finance officials. "I do not expect a sudden spike in long-term bond yields. In the long-run, if the economy recovers and inflation heads towards two percent, we might see nominal interest rates rise but that's natural."
There are several problems with this view. For one thing, Japan's government already spends 25% of its tax revenue to merely service the interest costs on its debt, at a time when 10-year yields have been well below 1% for an extended period and one can therefore expect the mix of outstanding debt to already reflect the ultra-low interest rate environment. Note that as of Friday, even after a large sell-off in the JGB market, 2 year yields are at a mere 11 basis points, 5 year yields at 28 basis points and 10 year yields at 69 basis points. Unfortunately for Japan, its public debt has by now grown so large that even the lowest interest rates in the world can not longer keep debt service costs from rising. In fact, they have been rising for the past six years already.
Here is an overview of Japan's 2013 budget. A full 49.1% of the government's revenue comes from the issuance of bonds (including the pension bond program). Only 46.5% comes from taxes. On the expenditure side, 24% of the total revenue will go toward debt service (note that 'policy spending' excludes the debt service costs in the chart below). Spending on social security, already the by far biggest portion of Japan's government spending has increased by 10.4% in the 2013 budget. This spending item is set to grow at an accelerated pace for many years to come, as Japan's society is now aging rapidly.
Japan's 2013 budget, revenue sources and spending- click to enlarge.
To summarize: the two biggest items of government expenditure are both set to soar in the years ahead. Abe 's idea is probably to attempt to 'inflate the debt away' in a kind of 'slow burn', but that may prove to be impossible because Japan's debt growth is already beyond the point of no return so to speak. Consider that is interest cost were to rise to 2%, the government's debt service costs would soon double (the doubling wouldn't be instantaneous, as only new debt will be issued at the higher rate).
If Japan's social security spending, which currently amounts to 29.2 trillion yen, continues to grow by 10% per year, it will exceed the current year's tax revenues by 5 trillion yen within just four years.
Even assuming that Kuroda-san will indeed have the process of rising interest rate under perfect control, it is hard to see how this can work out. What will happen though if yields on JGBs do spike? What will Japan's government do if JGB yields rise to 5% or even 10%? Note that 10 year JGBs yielded over 8% in 1989 at the peak of the bubble era.
The equanimity with which the world has so far greeted the latest Japanese monetary experiment seems extraordinarily misguided. Note that even the possible failure of the policy would likely have notable consequences (a global 'deflation scare' would undoubtedly ensue), but its possible 'success' seems fraught with immeasurably greater risk. Even if everything goes according to plan, it is difficult to fathom how Japan's government can possible remain solvent once bond yields rise, even if they don't rise by much. However, there is very little reason to believe that everything will actually go according to plan. History is riddled with money printing exercises that have gone horribly wrong. Japan remains the biggest 'gray swan' currently on the horizon.
Charts by: Kyodo Graphic, St. Louis Fed, BarCharts
Emigrate While You Can... Learn More
Dear readers - we want to once again thank all of you who have supported us with donations.
To donate Bitcoins, use this address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Thank you for your support!
One Response to “Japan: Free to Inflate in Peace”
Most read in the last 20 days:
- Why Do We Let Other People Tell Us What to Do?
Lame Theories of Government We have been disappointed with political ideas and theories of government. They are nothing but scams, justifications, and puffery. One tries to put something over on the common man… the other claims it was for his own good… and the third pretends that he’d be lost without it. Most are not really “theories” at all… but prescriptions, blueprints for creating the kind of government the “theorist” would like to have. Not surprisingly, it is a...
- Gold and Gold Stocks – Back to Tricky, but Interesting Signals Emerge
A Relentless Short Term Decline When we last discussed the gold sector, we noted that with gold approaching its 200 day moving average, a pullback had to be expected soon. In the meantime, a bit more than just a pullback has happened, as a severe sell-off started after the October FOMC announcement. Photo via genius.com However, as you will see below, this has most likely merely reset the clock a bit in terms of anticipating a medium term trend change (even if...
- Gold and Gold Stocks – It Gets Even More Interesting
Technical Backdrop If only we could get a dime for every bearish article on gold that has been published over the past two weeks...but one can't have everything. When a market is down 83% like the HUI gold mining index is, we are generally more interested in trying to find out when it might turn around, since it is a good bet that it is “oversold”. Of course, it if makes it to 90% down, it will still be a harrowing experience in the short term. We like these catastrophes because...
- The Greatest Racket of All Time
The Successes of the Global War on Terror One would think that the so-called “Global War on Terror”, which has been given fresh impetus by the Paris attacks, must be going swimmingly. What else could explain the great enthusiasm with which it is pursued? It may be recalled that it started in earnest after the WTC attack – also a declaration of war, as it was put at the time. As is often the case when Islamist fundamentalists strike, the actual attackers immolated themselves on...
- The Long, Cold Winter Ahead
Not Immune Cold winds of deflation gust across the autumn economic landscape. Global trade languishes and commodities rust away like abandoned scrap metal with a visible dusting of frost. The economic optimism that embellished markets heading into 2015 have cooled as the year moves through its final stretch. Photo credit: David Byrne If you recall, the popular storyline since late last year has been that the U.S. economy is moderately improving while the...
- How Do People Destroy Their Capital?
There is no Santa Claus I have written previously about the interest rate, which is falling under the planning of the Federal Reserve. The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one...
- Junk Bonds Under Pressure
While the Stock Market is Partying ... There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007. Photo credit: Getty Images At first it was assumed that the most highly...
- Angry Belgian Muslims and the Price of Welfare Statism
Ill-Tempered Mohammedans in the Socialist Paradise In the wake of recent revelations about the identities of the morons involved in the horrific Paris attacks (happily, most of them shuffled off the mortal coil as well, thereby improving the aggregate degree of moral clarity and intelligence in the world), a friend pointed us to an article at Unz Review that asks: “Why Does Belgium Have Such Angry Muslims?” Our instinctive, immediate reaction was to argue that the bland, boring...
- The Plane Incident in Syria
A Strange Event The topic of the SU-24 Russian plane shot down by Turkey over the weekend in Syria has been discussed all over the media ad nauseam by now, but we want to add a few observations and suggestions of our own. Some have perhaps not received the attention they possibly deserve. Image of Russian jet shortly after it was hit by a Turkish missile. Luckily someone was promptly at hand to make a qualitatively acceptable video of the incident. As is well known, cameramen...
- Can Investors Trust the New Gold Fixing?
Statistical Analysis of the New Gold Fixing Since 20 March 2015 a new gold price fixing organized by the London Bullion Market Association has been in operation. It has replaced the previous price determination process, which was in place for more than a century and became subject to criticism as it was highly vulnerable to manipulation. Has manipulation now ceased? Gold fixing at N.M. Rothchild and Sons offices in London. The first fixing took place there on 12 September...