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
Year-End Fund Raising Drive
Dear readers, our year-end funding drive has become a “beginning of the year funding drive” as we have yet to reach our target. By now you will be familiar with the many advantages a donation can secure for you, which range from sounder sleep, to children including you in their songs, to potentially obtaining privileges in the afterlife (no guarantees, but it seems highly likely). Lastly, a special thanks to all readers who have already made a contribution, we are greatly honored by your support.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “Japan: Free to Inflate in Peace”
Most read in the last 20 days:
- Gold and Gold Stocks – A Meaningful Reversal?
A Negated Breakdown There have been remarkable gyrations in the gold sector lately. The typical rebound out of a November/December low (typical in recent years after the end of the tax loss selling period) was initially cut short in January in the course of the global stock market decline. This was a bit surprising, because it was widely held that the recovery in the gold price was a result of said stock market decline. Photo via genius.com We suspect that in it was...
- The Walking Dead: Something is Rotten in the Banking System
A Curious Collapse Ever since the ECB has begun to implement its assorted money printing programs in recent years - lately culminating in an outright QE program involving government bonds, agency bonds, ABS and covered bonds - bank reserves and the euro area money supply have soared. Bank reserves deposited with the central bank can be seen as equivalent to the cash assets of banks. The greater the proportion of such reserves (plus vault cash) relative to their...
- The Bank of Japan – Ringing in the Endgame?
Let's Do More of What Doesn't Work It is the Keynesian mantra: the fact that the policies recommended by Keynesians and monetarists, i.e., deficit spending and money printing, routinely fail to bring about the desired results is not seen as proof that they simply don't work. It is regarded as evidence that there hasn't been enough spending and printing yet. BoJ governor Haruhiko “Fly” Kuroda: is that a windshield I'm seeing? Photo credit: Yuya Shino / Reuters At the...
- The FOMC Decision: The Boxed in Fed
An Imaginary Bogeyman What's a Keynesian monetary quack to do when the economy and markets fail to remain “on message” within a few weeks of grandiose declarations that this time, printing truckloads of money has somehow “worked”, in defiance of centuries of experience, and in blatant violation of sound theory? In the weeks since the largely meaningless December rate hike, numerous armchair central planners, many of whom seem to be pining for even more monetary insanity than the...
- The Bubble Deflates - And Crash Risk Rises
A Harrowing Friday – Momentum Stocks Continue to Break Down The release of Friday's payrolls report was the worst of all worlds for the US stock market. This typically happens in bear markets: suddenly fundamental data that wouldn't have bothered anyone a few months ago are seen as a huge problem. Why was it seen as problematic? The report somehow managed to be weak and strong at the same time – it showed weakness in payrolls growth, but the entirely artificial U3 unemployment rate,...
- Skyscraper Mania Goes Global
New Skyscrapers Wherever one Looks Readers may recall our recent discussion of the construction of the Jeddah Tower (see “Soaring to Bankruptcy” for details). This skyscraper is a typical symptom of an artificial boom that has moved past its due date, so to speak. The idea behind the skyscraper index is that in light of the immensity of projects that involve the construction of the tallest building in the world (or one of the tallest), they are only realized once the notion that boom...
- Gold's “Monkey Magic” - An Update on Gold and Gold Stocks
Has a Bull Market Begun? Gold stocks have risen so much and so fast recently that a pullback, resp. consolidation either has begun already or is likely to begin soon. We have therefore decided to post a brief update on the situation in order to discuss what might happen next. Back in late November, we made a few remarks in order to clarify why we have focused so much on the gold sector again since last summer. Processing plant of the Driefontein mine in South Africa Photo...
- Softening up the Rubes – the War on Cash Continues
More Anti-Cash Propaganda by Bloomberg Former NYC mayor Bloomberg is probably one of the worst nannycrats who ever strode upon the US political scene. No-one has done more to take the fun out of New York than this man (we have chronicled the efforts of people of his ilk in “America's Killjoys”). It always amazes us to no end when successful businessmen - once they have made enough money to last them a thousand lifetimes – suddenly discover their penchant for socialism and State...
- China’s $6.6 Trillion Toxic Loan Problem
Rotting Vegetables “As long as you’re green, you’re growing. As soon as you’re ripe, you start to rot,” once remarked Ray Kroc, mastermind of the McDonald’s franchise empire. At the moment, no truer words can be spoken for China’s ripe economy. The Middle Kingdom’s 30-year economic boom is being overcome with the unpleasant odor that befalls rotting vegetables. What’s more, there’s no way to reverse it. Photo credit: fmh Economic...
- In Praise of Sarah Palin…
Up and Down MUMBAI, India – The Dow dropped 208 points on Monday – or about 1.3%. After last week’s pause, it will be interesting to see if the sell-off resumes. “Global equities in turmoil,” reads a CNBC headline. “A month after raising rates, Fed faces darker global economy,” suggests an AP newswire report. Neither of these is true. The world has not changed significantly in the last month. What has changed? The squiggly lines are going down instead...