Whom The Gods Would Destroy...

 |  Includes: FXY
by: Acting Man

Japan in the Grip of Utter Madness

“Quem deus vult perdere, dementat prius,” is an ancient proverb often wrongly attributed to Euripides, which says: “Whom God wishes to destroy, he first makes mad.” It evidently applies in spades to the new leadership of the Bank of Japan. What is so astonishing to us is that this obvious conclusion is not shared by anyone in the so-called "mainstream." In short, it seems the Gods have made a whole bunch of people mad.

It is a widely accepted shibboleth that for reasons that are never properly explained, "deflation is bad for Japan." Not deflation of the money supply, mind, as that has never once happened anyway. A mild decline in consumer prices is what is widely regarded as such an unmitigated evil.

This is such hair-raising nonsense, one is almost at a loss for words. In a progressing unhampered market economy, falling prices for goods and services would be the normal state of affairs. After all, economic progress is all about doing more with less, or putting it differently, it is all about increasing economic productivity by means of capital accumulation.

The idea that "deflation is bad" has been reinforced by decades of Keynesian propaganda, but that constant repetition doesn't make it any more true. Of course, for those who are sitting closest to the printing press of the central banks, inflation is an advantage. Everybody else however gets shafted. And so Haruhiko Kuroda has apparently decided it would be a good idea to shaft the vast bulk of the population of Japan.

Inflation is always a bad idea, but it is an even worse idea in Japan. The country is aging rapidly and has practically no major raw materials resources except fish and rice. It must, therefore, import all major commodities, like crude oil, natural gas, iron ore, copper… you name it. By weakening the Japanese currency, the 90% of its economy that are not in the export business have just seen their import costs jump by 20% or more. Those in the export business are experiencing a one-off sugar high that will soon dissipate. Eventually their input costs will have caught up and their margins won't be any better than they were before. In fact, it is a very good bet they will be worse, as the current weakness in the global economy probably entices exporters to cut prices now that the exchange rate appears "favorable" to them.

The growing number of Japanese retirees who depend on fixed income will see the buying power of their savings rapidly erode. What might have been a fairly secure retirement could well become a nightmare henceforth.

Japan is a society in demographic decline. It should be blindingly obvious that a policy of inflation is the by far worst thing that can happen to it. One must therefore ask: what is the government's true motive? It can only be a misguided plan to "inflate away" its vast debt. However, that will actually require hyperinflation. Nothing can be gained by merely opting for "mild" inflation, as the cost of servicing the debt load would explode and so throw a major spanner into the works. So we are left to ask: is that that they want? Has the Japanese government embarked on a policy of default via hyperinflation?

Reuters reports:

“The Bank of Japan unleashed the world's most intense burst of monetary stimulus on Thursday, promising to inject about $1.4 trillion into the economy in less than two years, a radical gamble that sent the yen reeling and bond yields to record lows.

New Governor Haruhiko Kuroda committed the BOJ to open-ended asset buying and said the monetary base would nearly double to 270 trillion yen ($2.9 trillion) by the end of 2014 in a shock therapy to end two decades of stagnation.

The U.S. Federal Reserve may buy more debt under its quantitative easing, but with the Japanese economy about one-third of the size of the United States, the scope of Kuroda's "Quantitative and Qualitative Monetary Easing" is unmatched.

"This is an unprecedented degree of monetary easing," a smiling Kuroda told a news conference after his first policy meeting at the helm of the central bank. "We took all available steps we can think of. I'm confident that all necessary measures to achieve 2 percent inflation in two years were taken today," he said.

One of those steps was to abandon interest rates as a target and become the only major central bank to primarily target the monetary base — the amount of cash it pumps out to the economy. It adopted a similar policy in 2001-2006, but not on this scale. The scope of the changes Kuroda pushed through, and the fact he secured unanimous board support for them, drove the yen down sharply, knocked the 10-year bond yield to a record low, and nudged Tokyo share prices just shy of a 4-1/2 year closing high.

"The result is nothing short of regime change," HSBC's Japan economist Izumi Devalier said in a report. "The BOJ has now made a much firmer commitment to achieving its 2 percent inflation goal, and has demonstrated that it will do anything short of foreign-bond buying to achieve this goal."

The scope of Kuroda's overhaul offered immediate comfort to Japanese markets, but contains major risks. It could leave the central bank heavily exposed to government debt and potentially huge losses if it failed to stoke inflation and investors lost faith in its efforts to revive the economy, and it could trigger a currency war as other Asian exporters seek to remain competitive with a weaker yen.

"It is as if we've gone back to the quantitative easing of the 2000s," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management in Tokyo. "Targeting the monetary base will lead to a huge increase in current account balances that commercial banks keep at the BOJ, but I'm still not sure if this money will move through the economy."

(emphasis added)

It will be interesting to see how long Kuroda has reason to smile. He did have a good reason immediately after the announcement, though, as the markets went into party mode.

Market Reaction

It is interesting that apart from the yen, all markets affected by the decision decided to celebrate. Of course, a heavy dose of "free money" is always welcomed by the markets initially. The hangover comes later, but it will invariably come. What is especially astonishing is that 10 year JGB yields have fallen to a new all time low of just 42 basis points.

Yes, Kuroda's BoJ will be a big buyer in that market, but if it ultimately succeeds in attaining its inflation goal, then the JGB should be regarded as the short of the decade now. Obviously, should CPI race up by 2% per year (and the exchange value of the currency therefore be roughly cut in half cumulatively every 2 decades), a commensurate price premium will have to enter the JGB market. Unless of course we assume that all holders and buyers of JGBs are complete morons.

It is true that many participants in the financial markets, let's face it, are not necessarily the sharpest tools in the shed (everyone is of course free to count him or herself among the small percentage one might consider "smart"). As proof for this assertion, we offer the many times during the stock market mania of the late 1990s when e.g., stock "XYZ" was mentioned positively on CNBC, and immediately the prices of not only XYZ, but also ZYX, XZY, and YZY jumped higher in a frenzy of buying. The conclusion from that was that many market participants were not even in possession of rudimentary reading skills. However, bond market traders are usually considered to be a fairly sophisticated bunch. They may be piling into JGBs on Kuroda's announcement in the hope of selling to the BoJ at even high prices, but eventually the sobering up phase will come, and it probably won't be pretty.

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The JGB market reacts to Mr. Kuroda's announcement.

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The Nikkei index over the past two trading days. After initially declining ahead of the BoJ announcement, it raced higher thereafter. A daily chart follows below.

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On the daily chart, the Nikkei is almost, but not quite yet, at a new high for the move. As we have pointed out previously, if the "normal" cycle fails (i.e., if new highs are attained well beyond the usual March peak – note here that a peak in April would still be close enough to be considered part of the "normal" cycle), that would represent an important character change for this market.

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The yen hated what happened and suffered the biggest one day decline of its entire downtrend to date.

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Here is a chart in the manner in which USD-JPY is normally quoted, i.e., this shows how many yen are required to buy one U.S. dollar.


With Mr. Kuroda "delivering" on his promise, unanimously backed by the board of the BoJ to boot, we may have come a decisive step closer to the inevitable unraveling of the global fiat money system. There always was a chance that this unraveling would begin in Japan; its public debt is estimated to reach 245% of GDP this year, so it seems not out of the question that Shinzo Abe's government has decided to attempt to inflate this debt away.

With this, the government assumes that financial markets will just stand still and allow it to get away with it, an exceedingly unlikely outcome. The markets may well play along for some time, but eventually there will be an "oops" moment. In the beginning, inflation always appears to be a boon. Something seems to have been created out of nothing. Profits accrue seemingly without effort. However, it should be clear that this is not possible. Nothing has been added to the economy's real pool of capital. All that will happen is a misallocation of said capital as economic calculation is increasingly falsified by erroneous price signals. Eventually, a crisis of the underlying currency system will become highly probable, especially if the new inflationary policy persists.

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