Just Give Us a Minute to Erect that Roadblock …
There is indeed such a thing as reality, and in Japan it has its very own contours. Shinzo Abe's inflationary plan – dubbed by inventive sell-side analysts 'Abenomics' of late, as though every time someone comes up with the same hoary money printing scheme it must be given a new name – is just so … un-Japanese.
Japan has its own rhythm and mentality. In a way it is a bit akin to an ant heap and we don't mean that to sound like an insult, it's just a comparison that suggests itself. It is a society with iron discipline, extremely well developed rules on politeness, and a strongly ingrained sense of solidarity. When Japan was struck by the tsunami disaster, these qualities were on display for everyone to see and elicited great admiration all around the world. They also explain the – for Western observers at times difficult to understand – social compact along the lines of which the country is managed. Scores of hedge fund managers have despaired over the so-called 'widow-maker' trade of trying to short the JGB market, and all indications are that even now, when the chances to make money with this trade seemingly are better than ever, it just won't work:
(Click charts to enlarge)
The yield on the 10-year JGB; apparently the bond market is not at all impressed by Abe & Co
In order to understand Japan a bit better, one must never lose sight of the fact that it is a society in decline, at least in terms of its demographics (it remains an extremely efficient, wealthy and progressing economy). Japan's society is aging rapidly and has begun to shrink. The speed with which this happens is subject to a compounding factor. And precisely because Japan has a very tight-knit society that is set in its traditional ways, the country is not very welcoming to immigrants, so there seems to be no way out. Of course we don't know the future with certainty – recent trends are extrapolated and it is assumed that things will play out in a certain way. However, even from the perspective of the country's leadership, this is what the situation no doubt looks like.
The Japanese mentality is what has enabled the government to increase its debt into the blue yonder without a funding crisis erupting so far. It may of course happen at any moment, and in many ways it seems almost a mathematical certainty, but again, we can only make an educated guess regarding the eventual outcome.
However, we do know one thing, namely that the ministry of finance is the 'Ministry of Dreadful Dreams'. What the nightmares of its inhabitants consist of concerns mainly the chart depicted above. The one thing no-one there wants is for interest rates to rise. This one reason why Abe and his idea of 'reflating' the economy is without a doubt viewed with great apprehension by the establishment. It threatens to end its placid existence of measured decline management by upsetting the status quo. And of course the people concerned must be asking themselves why anyone would want to upset the status quo. Why would an aging population sporting ever more retirees need inflation? Of course one may as well ask why anyone would 'need' inflation, but in this case it is especially obvious how absurd the idea is.
And so it comes as no surprise that after Abe got to nominate two prominent inflationists to run the BoJ, the first signs of resistance are emerging.
Ex BoJ Board Member Mizuno Speaks Out
Former BoJ board member Atsushi Mizuno, a kind of elder statesman of the banking business in Japan, has laid out his views regarding Kuroda's options. A few excerpts:
“Haruhiko Kuroda will have limited options for aggressive easing if he’s confirmed as central bank governor as more Japanese government bond purchases heighten the risk of a market bubble, a former BOJ policy board member said.
“Kuroda will hit the wall of reality,” Atsushi Mizuno, vice chairman at Credit Suisse AG in Tokyo and a member of the BOJ board from 2004 to 2009, said in an interview today. “Increased bond buying would cause over-dependence on the BOJ and that’s not healthy for the market. I see the risk of a JGB bubble.”
“My concern is that Kuroda is over-emphasizing a bit too much his will to end deflation without explaining his plan for an exit strategy,” Mizuno said. “From the start he will try to do something new, but I expect he will eventually return to an extension of the current policy framework.”
“Productivity has to be much higher,” he said. “That has to be boosted by the government’s growth strategy. As Shirakawa has repeatedly said, monetary policy is only for buying time. It’s not a panacea.”
As a BOJ board member, Mizuno was an advocate of interest- rate increases before switching his position when the global financial crisis prompted the central bank to cut the benchmark rate and start buying corporate debt.”
We have little doubt that Mizuno speaks for the entire old-boys network that has so far managed Japan's affairs. His words no doubt carry some weight. He is essentially delivering a message to Kuroda: 'play around a little if you must, but please let's go back to business as usual as quickly as possible'. While it seems a bit late in the game to begin worrying about a 'JGB bubble', he predicts that Kuroda will in the end have no choice but to “return to an extension of the current policy framework”. That is obviously exactly what participants in the JGB market expect as well.
Abe is after all not the first Japanese prime minister of the post bubble era to make big waves early on in his term about reforming this and that (although he is the first to emphasize the alleged 'need for more inflation' so vehemently). Does anyone remember Koizumi? There was a lot of excitement when his administration came to power. After a few years, it turned out that nothing had changed.
Consider also the institutional framework: Japanese banks, pension funds and insurers are the biggest holders of JGBs. Upsetting the JGB market would hurt all of them and there can be no doubt that 10-year paper yielding 58 basis points would be 'upset' if price inflation actually reached 2% per year. One reason why especially the banks hold so many JGBs, is that Japan offers very little scope for credit expansion. Whenever the BoJ has attempted to 'reflate' by means of asset purchases, the commercial banks have reduced credit almost commensurately. Money supply growth has therefore remained negligible.
It also seems that Shirakawa's views are widely supported in the monetary policy establishment; the need for overtly inflationary policy is just not seen, and rightly so. Not an iota of additional wealth can be created by printing more money after all. This is of course not to say that there is no scope for reform in Japan, on the contrary. However, inflation is not reform, it is just inflation.
The Yen and Gold
The more we think about this, the more we become convinced that while the recent decline in the yen may have been egged on by Abe's pronouncements, the main reason for the move was simply the increasingly confident 'risk on' environment in financial markets worldwide. A lot of money has apparently been 'parked' in the yen and the Swiss franc for safety reasons. This also explains why gold fell initially from its 2011 highs when the SNB deliberately weakened the CHF and then again when the yen tanked: a lot of money that was 'hiding' in gold purely out of fear of systemic risk has been redeployed on these occasions.
Should Mizuno turn out to be correct, then both the yen and gold will provide protection against the inflationary policies pursued elsewhere. On the other hand, it seems almost certain that Kuroda will at least experiment a little in the early stages of his governorship, and that means that we will see the Fed, the BoE and the BoJ inflating in concert for several months (the ECB will likely only join in again if and when the euro-land debt crisis becomes acute again).
This in turn means that the focus of the gold market may well shift from reflecting systemic risk to reflecting the risk that all these inflationary measures will turn out to be the equivalent of the sorcerer's apprentice problem:
“Die Geister die ich rief…” ("The spirits that I called…")
The sorcerer's apprentice in the “so far, so good” stage of his little experiment …
(Image credit: Walt Disney)