A Litany of Failures
It was widely expected that the BoJ would announce something this week after it promised to perform a comprehensive review of its monetary policy. It certainly did deliver a major tweak to its inflationary program, but its implications were seemingly not entirely clear to everybody (probably not even to the BoJ).
This picture was taken back when the BoJ first introduced NIRP, but it has the appropriate horror movie atmosphere. Kuroda’s press conferences with these nifty little placards remind us a bit of school. As an aside, the term “quality” evidently got there by mistake. One cannot improve a money’s quality by increasing its quantity and enforcing negative rates (these are a particularly dangerous abomination).
Photo credit: Yuya Shino / Reuters
There were many reasons for the BoJ to review its policies. For one thing, they have killed the bond market. Trading volume in JGBs has collapsed, and by pushing yields all along the curve to zero or lower, insurers and pension funds are increasingly in dire straits. Moreover, the BoJ’s purchases of ETFs have made it an outsized shareholder in many listed Japanese corporations. This is tantamount to introducing socialism by the back door.
Last but not least, these policies are simply not working – not by the standards of the planners themselves and not even in the short term (that they cannot possibly work in the long term probably doesn’t need to be belabored). This shouldn’t have surprised anyone, since they haven’t worked in Japan for 26 years running. Why should that suddenly change? The BoJ has not even been able to hit its absurd consumer price inflation target:
The annual rate of change of Japan’s CPI. After Kuroda’s money printing program started in 2012, there was a bump in CPI and consumer spending in 2014 as Japan’s sales tax was doubled. Thereafter CPI returned to negative territory where it has remained stuck for the past five months – click to enlarge.
Japan’s citizens should be relieved that the BoJ has failed to ignite consumer price inflation, since they would simply have become poorer if it had succeeded. Consumers need rising consumer prices like a hole in the head, particularly Japan’s aging population. Japan’s economy remains moribund as well though, as both massive deficit spending and money printing continue to fail to exert even the slightest positive effect.
Normally the diversion of resources into capital malinvestment by means of monetary and fiscal pumping will at least tend to boost “activity” in the short to medium term. This will in turn push up aggregate economic data as well, until the artificial boom collapses again. It seems in Japan not even these pretend prosperity phases can be produced anymore.
According to the playbook of today’s central bankers this is not considered evidence that their policies are failing. Rather, it is considered evidence that they are “not doing enough”. It was therefore to be expected that Kuroda would unveil fresh interventionist measures. These still fell short of the introduction of “helicopter money”, but not by much.
A Confusing Announcement
The latest tweak to the BoJ’s program to inflate Japan to prosperity consists inter alia of the central bank committing itself to “controlling the yield curve”, which is somewhat reminiscent of the war-time agreement between the Fed and the US Treasury (the original “Operation Twist”), in which the Fed promised not to allow treasury bond yields to rise beyond a certain threshold. While low, that threshold was at least positive though.
In the BoJ version of this policy the commitment is to keep the JGB yield (i.e., the 10 year government bond yield) at zero (!) and allow yields on longer maturities to rise so as to give the above mentioned insurers and pension funds a chance to earn a paltry return for taking a huge and growing risk. The short end of the curve is apparently supposed to remain in negative territory. A first sign that this caused some confusion was evident in the reaction of the yen:
The yen at first sold off on the BoJ announcement, but then reversed and rallied sharply (note: this chart shows the reverse of the usual USD-JPY notation – up indicates the yen is getting stronger) – click to enlarge.
Obviously, if the BoJ commits to alter its “QQE” program in the above described manner, it could mean that it will buy fewer bonds than it has bought up to now. If the JGB yield target is zero, it is even conceivable that it may need to sell JGBs if/ when JGB yields fall below the target rate. And yet, Kuroda also said that while the size of the QQE program would eventually become variable, the BoJ would keep purchasing bonds at the current pace for the foreseeable future (which doesn’t seem to make sense).
What if global government bond markets were to sell off though? In that case the opposite could happen – the BoJ could be forced to buy nigh infinite amounts of JGBs to defend the zero percent yield target. So this commitment to control the yield curve is an open invitation to a combination of utter disaster and shredding whatever is left of the BoJ’s vaunted “credibility”.
This is all the more so if one considers the plainly contradictory second major tweak to the BoJ’s policy – which represents easily the craziest measure since Kuroda’s appointment to the post of BoJ governor, and that is saying something. It consists of a so-called “inflation-overshoot commitment”, meaning that the BoJ promises to expand the monetary base until its 2% inflation target is exceeded and remains “stable” above this target.
This is obviously based on the erroneous premise that the central bank is “bigger than the market”. The assumption seems to be that it will actually be able to keep JGB yields at zero, even if consumer price inflation surges to levels above 2%.
Be careful what you wish for…
Cartoon by Bob Rich
In theory it would certainly be possible, since the only limit to how many bonds the BoJ can buy is the number of outstanding bonds – which the government can increase without limit if need be. The BoJ creates the money it buys securities with literally from thin air, at the push of a button, so it is not constrained by money as such. But it cannot possibly control everything. In this case, the pressure would simply escape through a different valve, namely the currency.
Along similar lines, there seems to be an unstated assumption that a central bank that has so far not even been able to push consumer price inflation rates up by doing everything to debase its currency, will somehow be able to keep price inflation in check if or when it finally does rear its head. It seems more likely to us that a chimpanzee will one day find the answers to all unresolved questions of theoretical physics.
One More Chapter to Come
Ever since Shinzo Abe’s recent election victory, the probability that Japan’s authorities will adopt some form of ”helicopter money” policy has greatly increased – even though direct government financing by the central bank is actually illegal (so far, that is; there have been so many BoJ rule changes since the bursting of the 1980s bubble that getting around this prohibition should pose no problem whatsoever).
We have discussed this in detail in “The Central Planning Virus Mutates”, after serial money printer and roving monetary crank Ben Bernanke visited Japanese policymakers to dispense his advice. Abe himself keeps hinting at “collaboration” between the government and the BoJ. And clearly, just as there is no end in sight to monetary debasement, there is no end in sight to deficit spending either:
Japan’s annual budget deficit in percent of GDP: the Abe/ Kuroda era has so far given birth to some of the largest annual deficits of the post WW2 era – click to enlarge.
We discussed Japan’s fiscal quandary back in 2013 and 2014. On these occasions we made the case that Japan’s combination of deficit spending and money printing is one of the biggest Ponzi schemes in the world (see “Japan – Worrisome Trends in Government Spending” “Free to Inflate in Peace” and “JGBs – the World’s Strangest Market” for details).
Of course, all the developed welfare/warfare States are running Ponzi schemes, but Japan’s appears closest to reaching its limit. The problem is that the so-called “non-discretionary” portions of its deficit are running away at an ever increasing pace – among them debt service costs and social security spending. The BoJ’s policies are taking care of debt service costs, but this is of course only a temporary illusion – the bill will still come due in some shape or form.
A slightly dated chart of the composition of Japan’s government spending. Abe is itching to increase defense spending, so this item is set to rise as well. The accelerating surge in social security spending seems unstoppable – click to enlarge.
Given the collective whining for more deficit spending that recently (re)emerged from monetary bureaucrats and their courtier economists at Jackson Hole and and the well-known penchant of Japanese governments for wasting untold amounts of money on “stimulus”, one should certainly expect that even more experimentation is in store.
In other words, the next step – helicopter money – undoubtedly remains on the table. What other way is there to expand this obscene debt-berg even further?
Conclusion – A Race Toward the Cliff
The world’s central planners are in a trap of their own making. Their policies have done so much damage that even the pretend prosperity of capital-consuming artificial booms can no longer be summoned – apart from the creation of ever greater and ever more dangerous asset price bubbles.
It has been obvious for some time that the world’s politicians and central planners are either too obtuse or simply unwilling to admit that economic growth cannot be conjured into being by top-down interventionism in the form of monetary pumping and deficit spending. The absurd pronouncements made at G-20 meetings confirm that magical thinking prevails among policymakers everywhere (see: We Can All Relax Now – G20 Politicians Will Produce “Growth” and The Gasbag Gabfest for some color on this collective elitist hallucination).
Japan is at the forefront of the race toward the cliff, mainly because its bubble economy bit the dust in 1990 already and its bureaucrats have been busy trying to “rescue” the economy for a decade longer than those elsewhere. Japan is a rich country; its people have accumulated a lot of capital back when its economy was much less hampered than it is today, and it is still home to a highly productive and creative private sector. This has allowed it to muddle along for a very long time now, but time may be beginning to run short.
Similar to other Western-style regulatory democracies, the political-bureaucratic class of the country – in an effort to justify its existence and to create income and sinecures for its cronies – has first regulated and taxed said private sector to death, and then tried to subsidize it back to life. The BoJ’s and Shinzo Abe’s policies are essentially nothing but this subsidization writ large (very large).
What does the “race toward the cliff” actually entail? The core problem as we see it is that the technocratic elites, in a mixture of desperation and misguided faith in false economic doctrines, are crushing the market economy. The so-called “third way” between free market capitalism and socialism is failing, and from the perspective of the planners, the logical solution is a flight forward in exactly the wrong direction, toward a centralized command economy and total control (after all, they would have little to do and enjoy no political power in a truly free society).
All of one mind… (well, maybe not all of them)
Cartoon by Gary Larson
The Western intelligentsia, with prominent Keynesian economists in the forefront, believed until the very last moment that the Soviet Bloc’s economy was not only viable, but would actually overtake the capitalist economies. Mises had shown in 1920 already that this type of economy was literally impossible – and he had done so on the basis of sound economic theory. There was an intensive debate over the socialist calculation problem that lasted well into the 1940s, which the socialist falsely claimed to have won (their arguments had gone through endless contortions until they ended up proposing “market socialism”, essentially the crowning absurdity. “OK, we have no market, so we will play market”).
In reality, Mises’ contentions have never been refuted. It is to be suspected that some failed to really understand them, which would certainly make refuting them rather difficult. Those in the socialist camp were ultimately reduced to pointing to the fact that the Soviet Bloc did exist, hence a socialist economy had to be possible (they overlooked a few crucial details, such as e.g. the fact that market prices existed elsewhere in the world). And yet, even though Mises’ theoretical disquisition has in the meantime been confirmed by incontrovertible empirical evidence as well, the belief in the efficacy of central economic planning and interventionism continues to fester in nominally capitalist countries.
Ludwig von Mises has made quite a few remarkable predictions, and there is one major forecast that has yet to come to pass (although one could probably argue that it already has in places like Greece and Cyprus). It concerns precisely this issue – he considered the “third way system” to be just as non-viable as socialism, since it would inevitably drift ever further away from a free market system (see also our most recent missives on this topic: “How the Welfare State Dies” and “The Coming End of the “Third Way” System”).
Mises argued that every failing intervention would beget fresh interventions to “fix” these failures. Eventually, everything would come under bureaucratic command and we would no longer be in a “third way” system, but in some type of Zwangswirtschaft (literally translated, a “coerced economy”). The actions of modern-day central banks certainly represent a vivid illustration of this process.
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