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
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “Japan: Free to Inflate in Peace”
Most read in the last 20 days:
- Gold Sector: Positioning and Sentiment
A Case of Botched Timing, But... When last we wrote about the gold sector in mid February, we discussed historical patterns in the HUI following breaches of its 200-day moving average from below. Given that we expected such a breach to occur relatively soon, the post turned out to be rather ill-timed. Luckily we always advise readers that we are not exactly Nostradamus (occasionally our timing is a bit better). Below is a chart of the HUI Index depicting the action since the January...
- India: The next Pakistan?
India’s Rapid Degradation This is Part XI of a series of articles (the most recent of which is linked here) in which I have provided regular updates on what started as the demonetization of 86% of India's currency. The story of demonetization and the ensuing developments were merely a vehicle for me to explore Indian institutions, culture and society. The Modimobile is making the rounds amid a flower shower. [PT] Photo credit: PTI Photo Tribal cultures face...
- The Long Run Economics of Debt Based Stimulus
Onward vs. Upward Something both unwanted and unexpected has tormented western economies in the 21st century. Gross domestic product (GDP) has moderated onward while government debt has spiked upward. Orthodox economists continue to be flummoxed by what has transpired. What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity. Although the fat lady has so far only...
- Welcome to Totalitarian America, President Trump!
Trump vs. the Deep State If there had been any doubt that the land of the free and home of the brave is now a totalitarian society, the revelations that its Chief Executive Officer has been spied upon while campaigning for that office and during his brief tenure as president should now be allayed. Image adapted from the cover of “Deep State #5” - depicting an assassin from the future President Trump joins the very crowded list of opponents of the American...
- Boosting Stock Market Returns With A Simple Trick
Systematic Trading Based on Statistics Trading methods based on statistics represent an unusual approach for many investors. Evaluation of a security's fundamental merits is not of concern, even though it can of course be done additionally. Rather, the only important criterion consists of typical price patterns determined by statistical examination of past trends. Fundamental considerations such as the valuation of stocks are not really relevant to the statistics-based trading...
- Searching for Truth
Heresy or Truth? RANCHO SANTANA, NICARAGUA – In the fifth century, Christian scholars counted 88 different heresies. Arianism. Eutychianism. Nestorianism. If there was a way to “offend” God, they had a name for it. One group of “heretics” argued that there was no such thing as “original sin.” Another denied the trinity. And another claimed Jesus was not divine. Which one had the truth? Depiction of the first Council of Ephesus in 431 AD, convened by Emperor...
- March to Default
Style Over Substance “May you live in interesting times,” says the ancient Chinese curse. No doubt about it, we live in interesting times. Hardly a day goes by that we’re not aghast and astounded by a series of grotesque caricatures of the world as at devolves towards vulgarity. Just this week, for instance, U.S. Representative Maxine Waters tweeted, “Get ready for impeachment.” Well, Maxine Waters is obviously right – impeaching the president is an urgent...
- Why the 21st Century Sucks - Turtles All the Way Down
A Truly Sucky Century BALTIMORE – What an awful century! Worst we’ve ever seen. Household incomes are down. Employment is down, with 7 million people in the U.S. of working age without jobs. Productivity growth is down. GDP growth is down – to only about 0.5% per capita last year. Even life expectancies are down. Drug overdoses are up. Suicides are up. One out of every eight children lives in a family getting food stamps. One of out every eight adults takes psychoactive drugs...
- Gold and the Fed's Looming Rate Hike in March
Long Term Technical Backdrop Constructive After a challenging Q4 in 2016 in the context of rising bond yields and a stronger US dollar, gold seems to be getting its shine back in Q1. The technical picture is beginning to look a little more constructive and the “reflation trade”, spurred on further by expectations of higher infrastructure spending and tax cuts in the US, has thus far also benefited gold. From a technical perspective, there are indications that the low at $1045.40,...
- The Unstable Empire – A Campfire Tale
Campfire Tale Caesar: The Ides of March are come. Soothsayer: Ay, Caesar, but not gone. — Julius Caesar, Shakespeare GRANADA, NICARAGUA – Today, we stop the horses and circle the wagons. For 19 years, we have been rolling along, exploring, discovering. We began with the assumption that we didn’t “know” anything - so we kept our eyes open. Now we know even less. Famous people who knew nothing and were not shy to admit it: Sergeant Schultz...
- Off the Beaten Path in Mesoamerica
Greeted by Rooster There’s an endearing quality to a steadfast rooster call at the crack of dawn when overheard from a warm country farmhouse. There’s a reassuring charm that comes with the committed gallinaceous greeting of daybreak that’s particularly suited to a rural ambiance. The allure of a morning cock-a-doodle-doo somehow falls flat in all other settings. Good morning everyone! Before meteorological forecasts were available on TV and smart phones, people...
- Why Silver Went Down – Precious Metals Supply and Demand
Rumor-Mongering vs. Data The question on the lips of everyone who plans to exchange his metal for dollars—widely thought to be money—is why did silver go down? The price of silver in dollar terms dropped from about 18 bucks to about 17, or about 5 percent. Reportedly silver was already assassinated in the late 19th century... so last week they must have assassinated its corpse. [PT] Illustration taken from 'Coin's Financial School' The facile answer is...