The BoJ Goes Even Crazier
It has been clear for a while now that the lunatics are running the asylum in Japan, so perhaps one shouldn’t be too surprised by what happened overnight. Bloomberg informs us that “Kuroda Jolts Markets With Assault on Deflation Mindset”.
The policy hasn’t worked so far, in fact, it demonstrably hasn’t worked in Japan in a quarter of a century. Therefore, according to the Keynesian mindset, we need more of it. Mr. Kuroda therefore delivered a surprise spiking of the punchbowl that immediately impoverished Japan’s consumers further by causing a sharp decline in the yen:
“Today’s decision to expand Japan’s monetary stimulus may be regarded as shock treatment in the central bank’s effort to affect confidence levels. Bank of Japan Governor Haruhiko Kuroda’s remedy to reflate the world’s third-largest economy through influencing expectations saw the yen sliding and stocks climbing.
Kuroda led a divided board in Tokyo in a surprise decision to expand unprecedented monetary stimulus. Bank officials hadn’t provided any hints in recent weeks that additional easing was on the cards to help reach the BOJ’s inflation goal. Kuroda, 70, repeatedly indicated confidence this month that Japan was on a path to reaching his 2 percent target in the coming fiscal year. Just three of 32 economists surveyed by Bloomberg News predicted extra easing.
“We have to admit that this is sort of a second shock — after we had the first shock in April last year,” said Masaaki Kanno, chief Japan economist at JPMorgan Chase & Co. in Tokyo, referring to the first round of stimulus rolled out by Kuroda in 2013. Kanno, who used to work at the BOJ, said “this is very effective,” especially because it comes the same day as the government pension fund said it will buy more of the nation’s stocks.
So why is there allegedly a “need to combat the deflation mindset”? Below is a chart of the recent increases in Japan’s CPI.
In actual practice, it matters little how they have come about – the fact that CPI was inter alia boosted by a hike in consumption taxes does not alter the fact that every consumer in Japan is now getting fewer goods and services for his income and savings than before. No consumer is going to a shop and saying to himself “the fact that things are now vastly more expensive than before somehow shows we are still in deflation, because it has happened for transitory reasons”. All he knows is that he is getting less for his hard-earned money. Mr. Kuroda is evidently not moved by such considerations.
Bloomberg’s article continues along precisely these lines:
“A decline in demand following April’s sales-tax increase and the tumble in oil prices are putting downward pressure on prices in Japan. Today’s decision came hours after a government report showed that core inflation eased to the slowest pace in six months in September.
The 3 percent gain in core consumer prices — the BOJ’s main gauge — was just 1 percent with the effects of April’s sales-levy hike stripped out.
The BOJ today reduced its estimate for the core consumer price index, which excludes fresh food and increases to sales tax, to 1.7 percent for the fiscal year through March 2016, from 1.9 percent previously. The bank kept its forecast at 2.1 percent for the following year.
The central bank won’t hesitate to act again if needed, Kuroda said, pointing out there’s still room for additional measures. The BOJ acted as skeptical views mount over the effect of quantitative easing, according to Citigroup Inc. economists Kiichi Murashima and Naoki Iizuka. “If the impact of today’s action on the economy and prices proves limited, the impact on financial markets may also prove short-lived,” they wrote in an e-mailed note.
The above is a corollary to the recently heavily propagated idea that falling oil prices are somehow “bad” for oil consuming countries because they might lead to lower prices! You can read this nonsense in every statist rag, from the Financial Times to the Economist. If this doesn’t prove how utterly absurd the basis of today’s central bank policies is, nothing ever will. These people have taken complete leave of what was left of their senses.
Although it shouldn’t be necessary to say this, here is a reminder: rising stock prices are not “proof” that things are fine. If that were the yardstick by which to measure the “success” of central bank money printing, the best performing economies in the world would be those of Venezuela, Argentina and Iran.
Kuroda’s Policy Will End in A Catastrophe
In order to explain why the pursuit of Kuroda’s policy is edging ever closer to a catastrophic outcome, we have to delve a bit into the details of Japan’s monetary data. In spite of the BoJ’s “QE” reaching record highs, it mainly creates bank reserves and furthers carry trades. The economy sees no private credit growth so far.
Commercial banks in Japan continue to shrink the stock of fiduciary media – this is to say, they are reducing outstanding credit, which makes more and more unbacked deposit money disappear. Hence, Japan’s money supply growth has recently decline to a mere 4.3% year-on-year, as the rate of contraction in outstanding fiduciary media (i.e., uncovered money substitutes) has accelerated to 9.4 annualized in spite of the BoJ’s pumping.
The reason is a technical one: contrary to the Fed, the BoJ buys most of the securities it acquires in terms of its “QE” operations directly from banks – this creates new bank reserves at the BoJ, but no new deposit money. By contrast, the Fed buys only from primary dealers, which are legally non-banks (even though most of them belong to banks). This creates both bank reserves and deposit money concurrently. The BoJ’s actions can only directly inflate the money supply to the extent it buys securities from non-banks, e.g. when it buys stocks in REITs to prop up the Nikkei.
Below is a chart showing the annual growth rate of Japan’s narrow money supply M1, which is essentially equivalent to money TMS (it comprises demand deposits and currency).
In short, the effectiveness of the BoJ’s pumping depends on the extent to which commercial banks are prepared to employ additional bank reserves to pyramid new credit atop them and thereby create additional fiduciary media. Japan’s banks are doing the exact opposite, mainly because there simply isn’t sufficient demand for credit. Why would anyone borrow more money, given Japan’s demographic situation?
However, one result of this is that an ever larger portion of Japan’s money supply actually consists of covered money substitutes – deposit money that is “backed” by standard money. Covered money substitutes have grown by more than 77% over the past year.
Bank reserves can be transformed into currency when customers withdraw cash from their deposits, hence to the extent that deposit money is “backed” by bank reserves, it ceases to be a form of circulation credit. The narrow money supply in total now amounts to roughly 595 trillion yen; of this, roughly 139 trillion yen consist covered money substitutes and 83.4 trillion yen consist of currency (outstanding banknotes in circulation). Thus the stock of fiduciary media has shrunk to 372.6 trillion yen.
And yet, in spite of Japan’s money supply growing much slower than money supply in both the US and the euro area, the yen continues to implode:
The yen’s ongoing collapse suggests that Kuroda will eventually get his inflation wish, as import prices continue to rise. In fact, Japan recently regularly reports trade deficits, which is inter alia a result of the plunge in the yen’s external value. Currently, this is offset to some extent by the decline in commodity prices, but given that commodities are by now extremely cheap relative to financial assets such as stocks and bonds, it becomes ever more likely that this offset will eventually reverse.
The question is though, why is the yen falling so much if Japan’s money supply isn’t expanding at a very strong rate? We believe the answer to this question is to be found in the following statistics:
It is well known that Japan has a very high public-debt-to GDP ratio. Even with the recent economic upswing, its budget deficit for the current year is projected to clock in at more than 7% of GDP – the latest in a string of huge annual deficits. What is less well known is the ratio of public debt to tax revenues, which is actually the more relevant datum:
We conclude from this that the markets are pouncing on the yen because they are forward-looking: the BoJ is monetizing ever more government debt and this is expected to continue, because the public debtberg has become too large to be funded by any other means.
In spite of the relatively low money supply growth this debt monetization has produced so far, it also creates the perverse situation that an ever greater portion of the government’s outstanding stock of debt consists actually of debt the government literally “owes to itself”.
On the surface, this monetarist wizardry suggests that one can indeed “get something for nothing” – but that just isn’t true. Deep down, market participants know that it isn’t true – so even though they are celebrating the promise of more liquidity by sending Japanese stocks soaring, they are also creating a fault line – and that fault line is the external value of the yen.
Among the industrialized welfare states, Japan is the one that is closest to government bankruptcy. Even with interest rates at record lows, the proportion of debt growth that is caused by mounting debt servicing costs alone has begun to rise in recent years due to the sheer size of the public debt outstanding. In other words, the government is by now in a so-called “debt trap”.
It has only been able to avoid more grave repercussions so far because Japan has run a current account surplus for a long time, and and only very few foreign investors therefore own JGBs. Japan’s own state-owned financial institutions such as the Post Bank and the state-owned pension fund have invested a large part of the population’s savings predominantly in JGBs.
And yet, the seeming calm rests on what appears to be increasingly misplaced confidence. All that is needed to blow the entire scheme to smithereens is an event that leads to a cracking of this confidence. Once a critical mass of economic actors becomes convinced that the plan is indeed to “make the public debt disappear” by monetization, and given what markets have done so far, it seems increasingly likely that it is the yen that will crack first. However, the sign that the ship is actually capsizing will be when JGB values begin to plummet in spite of the BoJ’s buying of government debt.
The growing amount of bank reserves piling up as a corollary to the BoJ’s exploding holdings of JGBs are like tinder waiting for a spark to set it off. Since Japan’s financial institutions hold large amounts of JGBs as ‘risk free’ assets augmenting their capital, their solvency will come into doubt should JGBs begin to decline in value. This is likely to happen should the fall in the yen’s external value get out of control. In that event, large portion of the covered money substitutes sitting in accounts may actually be converted into currency by panicked depositors. Then Mr. Kuroda will be reminded of the old saying “be careful what you wish for”.
Japan’s aging population needs rising prices like a hole in the head. The more “successful” Mr. Kuroda becomes in forcing prices up, the less money people will have to spend and invest. The economy will weaken, not strengthen, as a result. The advantages the export sector currently enjoys are paid for by the entire rest of the economy. moreover, even this advantage is fleeting. It only exists as long as domestic prices have not yet fully adjusted to the fall in the currency’s value.
If one could indeed debase oneself to prosperity, it would long ago have been demonstrated by someone. While money supply growth in Japan has remained tame so far, the “something for nothing” trick implied by the BoJ’s massive debt monetization scheme is destined to end in a catastrophe unless it is stopped in time. Once confidence actually falters, it will be too late.
Haruhiko Kuroda believes the economy is a machine, and he just needs to pull, the right levers.
(Photo credit : Stringer / Xinhua Press / Corbis)
Charts by: St. Louis Fed, StockCharts, BoJ, Tradingeconomics, Gail Fosler Group/IMF, Institute for New Economic Thinking
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
8 Responses to “The Experiment that Will Blow Up the World”
Most read in the last 20 days:
- Ganging Up on Gold
So Far a Normal Correction In last week's update on the gold sector, we mentioned that there was a lot of negative sentiment detectable on an anecdotal basis. From a positioning perspective only the commitments of traders still appeared a bit stretched though, while from a technical perspective we felt that a pullback to the 200-day moving average in both gold and gold stocks shouldn't be regarded as anything but a normal - and in this case actually long overdue -...
- Gold Sector Correction – Where Do Things Stand?
Sentiment and Positioning When we last discussed the gold sector correction (which had only just begun at the time), we mentioned we would update sentiment and positioning data on occasion. For a while, not much changed in these indicators, but as one would expect, last week's sharp sell-off did in fact move the needle a bit. Gold - just as nice to look at as it always is, but slightly cheaper since last week. Photo via The Times Of India The commitments of...
- Australian property bubble on a scale like no other
Australian property bubble on a scale like no other Yesterday Citi produced a new index which pinned the Australian property bubble at 16 year highs: Bubble trouble. Whether we label them bubbles, the Australian economy has experienced a series of developments that potentially could have the economy lurching from boom to bust and back. In recent years these have included: the record run up in commodity prices and subsequent correction; the associated...
- Prepare for the Unthinkable
Red Ink Growth and profits mask a variety of problems. They hide business inefficiencies and the money suck of corporate adminis-trivia. They also conceal unproductive staff. The final career leap But most of all growth and profits obscure the extreme value subtracting forces of bloated management teams. During good times it is unclear what these smug fellows do. During bad times it is lucidly clear that most of them ain’t worth a darn. When the...
- A Looming Banking Crisis – Is a Perfect Storm About to Hit?
Andy Duncan Interviews Claudio Grass Andy Duncan of FinLingo.com has interviewed our friend Claudio Grass, managing director of Global Gold in Switzerland. Below is a transcript excerpting the main parts of the first section of the interview on the problems in the European banking system and what measures might be taken if push were to come to shove. Andy Duncan of FinLingo.com (left) and Claudio Grass of Global Gold (right) Andy Duncan: How do you see the...
- US Stock Market - a Spanking May be on its Way
Iffy Looking Charts The stock market has held up quite well this year in the face of numerous developments that are usually regarded as negative (from declining earnings, to the Brexit, to a US presidential election that leaves a lot to be desired, to put it mildly). Of course, the market is never driven by the news – it is exactly the other way around. It is the market that actually writes the news. It may finally be time for a spanking though. Time for some old-fashioned...
- Love him or Hate him: Trump is the Revolution Against the Establishment
The U.S. Elections: The Latest Crack in the System The 2016 U.S. presidential elections are unprecedented: I don’t believe we have ever witnessed before a campaign year so toxic, so dangerously divisive and full of ad hominem attacks. Both camps have vilified the opposition and their followers, creating a schism in society. There has been no rational dialogue on the issues that truly concern the American public. The schism Illustration by : M. C....
- Meet Your New Stimulus Allocation Czar
March Towards Midnight The march towards midnight is both stirring and foreboding. Like a death row inmate sitting down to savor his last meal, a grim excitement greets the reality of impending doom. Thoughts of imminent mortality haunt each bite. Tic-toc, tic-toc... As far as the economy’s concerned, there’s no stopping its march towards midnight. The witching hour’s rapidly approaching. We intend to savor each moment and make the best of...
- Are the Deep State’s Drones Coming for You?
What’s Aleppo? Look out kid Don’t matter what you did Walk on your tip toes Don’t try "No Doz" Better stay away from those That carry around a fire hose Keep a clean nose Watch the plain clothes You don’t need a weather man To know which way the wind blows – “Subterranean Homesick Blues,” Bob Dylan The entrance to Baghdad's “Green Zone”. Photo credit: Karim Kadim / AP DELRAY BEACH, Florida – Biggest foreign policy blunder...
- Donald is Right – The System is Rigged
Scams and Flimflams BALTIMORE – For weeks, the top news headlines have been about politics. And politics has been all about the Republican Party candidate for president of the United States, Donald Trump. Two very different elections... The Establishment, the media, and most right-thinking people look around and sniff the air. Something stinks. And the smell, they say, is coming from that skunk, Trump. Meanwhile, Hillary, all greased up with expensive...
- Interview with Doug Casey
Natalie Vein of BFI speaks with Doug Casey Our friend Natalie Vein recently had the opportunity to conduct an extensive interview with Doug Casey for BFI, the parent company of Global Gold. Based on his decades-long experience in investing and his many travels, he shares his views on the state of the world economy, his outlook on critical political developments in the US and in Europe, as well as his investment insights and his approach to gold, as part of a viable strategy for...
- The Bamboozled Middle Class
Gassy and Bloated BALTIMORE – What a great time for an observer with a sense of mischief! This year’s presidential campaign is the most absurd and remarkable we have ever witnessed. After more than two centuries, Americans are finally getting the democracy they deserve – one that is grotesque... slimy... and immensely entertaining, albeit in the mud-wrasslin’ genre. The mud-wrestlers – well, we did promise you in these pages it would be entertaining like never...