This week the Bank of Japan confirmed their commitment to increase their monetary stimulus by setting an inflation target of 2%. Just like the US Fed, the stimulus is open-ended which means that there are no limitations set to the stimulus in amount or time. The Telegraph quoted several Japanese officials who have shown their commitment to continue their monetary easing policy:
“This opens a passageway toward bold monetary easing,” Mr Abe told reporters after the Bank of Japan and government jointly announced the inflation target and plans for “open-ended” central bank asset purchases similar to the strategy followed by the US Federal Reserve. Mr Abe began lobbying the central bank to ease monetary policy even before he took office late last month, saying more aggressive action was needed for the world’s No. 3 economy to escape from years of falling prices that can dull consumer spending and business investment.
Bank of Japan governor Masaaki Shirakawa vowed to achieve the inflation benchmark “as soon as possible,” but said that bold efforts were also needed from the government in order to achieve the target. Mr Shirakawa told a news conference that the two Bank of Japan board members, Takehiro Sato and Takahide Kiuchi, who dissented on setting the 2pc target argued that it far exceeded the pace of price growth that could be deemed sustainable in Japan, and that efforts must first be made to boost Japan’s growth potential.
In his weekly commentary Michael Pento from Pento Portfolio Stragies has put this decision into perspective.
Japan has already suffered through a quarter century’s worth of an economic malaise because they have refused to allow the free market to work its reconciliation magic. Their reliance on government borrowing and spending to rescue the economy has proven to be a miserable failure. Because of this fact, Japanese politicians have succeeded to increase the debt to GDP ratio to 237%, which should have already caused a collapse in Japanese Government Bonds (JGBs) and the Yen.
However, JGBs have held their value for two reasons: The Japanese own 92% of their sovereign debt; And, up until now, deflation has reigned over the island.
Since foreigners do not own a large portion of Japanese bonds, there isn’t a big concern about a mass exit from JGBs due to the fear of a weakening Yen. If foreign ownership of sovereign debt was more in the area of 50% (like it is in the U.S.), there would be a palpable fear on the part of those creditors that their wealth could be wiped out upon currency repatriation—especially in light of the new administration’s love affair with inflation and a falling currency. More importantly, since aggregate prices have dropped in 10 of the last 15 years and inflation has averaged a negative 0.6% in the last 4 years, holders of JGBs weren’t so concerned about yields being so close to zero percent. Falling prices allowed the government of Japan to issue debt with very little cost.
As of now, the Japanese 10-year note yields just 0.75%. That’s a very poor yield; but since holders of Yen are currently experiencing deflation, they still are provided with a real return on their investment. But if inflation does indeed rise to 2%, the yield on the 10-year note would have to rise above 3.3% in order to offer the same real yield seen today.
Indeed, the decision of the Japanese to inflate their economic growth is not an isolated decision. It could be that Japan is a closed market, they are not operating in a vacuum. The “unintended consequences” of their decision could reach to a global scale. In particular, the currency devaluation which is the result of the inflationary policy, is not exactly the type of outcome that the other economic powerhouses wished for. The US President has committed in his 2010 speech to drive up the US exports with 50% by 2014/5. The following charts show the declining value of the Yen and the increasing USD/Yen ratio. (Courtesy Stockcharts.com and Investing.com)
This trend brings the global currency war front stage globally. European Central Bank policymaker Jens Weidmann warned about the threat of a currency war as reported by Telegraph: “So far the international currency system has come through the crisis without a devaluation competition, and I hope very much that remains the case.” Of course it would be wishful thinking to believe that the world can avoid a currency war.
In fact, author of the book “Currency wars” Jim Rickards keeps on repeating in a very outspoken way that we are in the early stages of such a war. He pointed earlier this week to the relationship between a currency and gold.
“You have to pick your currency. In dollar terms the gold price has not gone up that much but in yen terms, with the devaluation of the yen, gold is going up a lot. Gold is a function of the currency wars. The country that is weaking the currency the most is where gold is going up the most.”
Herein lies part of the answer why dollar gold (as well as euro gold have not been appreciating lately). Precious metals strategist Konstantinos Xeroudakis sent us the following two charts. They show the expansion of the balance sheet of the Bank of Japan in 2012 while the US Fed’s balance sheet did not expand significantly. It could appear counterintuitive in the light of the recent US Fed bond buying programs announced in Q3 and Q4, but the Fed has basically been buying an equal amount of bonds as the ones that have been maturing, which is bottom line a net net situation.