"Almost the entire rich world is stuck in a zero interest rate liquidity trap situation, and I think everybody is haunted by the possibility that there's no way out of it. If Japan shows a way out of that, it will be very encouraging." -- Greg Ip, U.S. editor of the Economist
This is big, really big. In fact, according to the analysts at Nomura, the Bank of Japan's (BoJ) aggressive bond buying program will be five times larger than the Fed's QE as a percentage of GDP. And, while the Fed has purchased a mere 25 percent of gross government bond supply (US Treasuries), newly-appointed BoJ chief Haruhiko Kuroda plans to buy an eye-watering 72.9 percent.
Do you think that will be enough to push down long-term interest rates?
You're darn-tootin' it will. It's also going to send equities to the moon, which it already has. Take a look at this from last week's Wall Street Journal:
"Japan's Nikkei Stock Average soared to a fresh multi-year high as investors cheered the Bank of Japan's latest monetary easing measures.
"In Tokyo, the Nikkei rose to its highest level since August 2008 after the Bank of Japan announced a set of bolder-than-expected monetary easing measures under new central bank Governor Haruhiko Kuroda Thursday as part of its commitment to end deflation. The index ended up 1.6% at 12,833.64 after rising as high as 13,225.62 in early trading.
"'Foreign investors now have no choice but to buy Japanese stocks,' said Kenichi Hirano, market analyst at Tachibana Securities. 'Europe remains mired in debt and employment problems, while U.S. shares are looking very pricey. Japan is the most undervalued market in the world, offering the best chance for equity price appreciation.'" ("Nikkei Soars on BOJ Easing Moves", Wall Street Journal)
Nothing like a little free money to ignite the risk trade, eh? Naturally, the announcement sent the yen plunging to new lows, clearing the way for a surge in Japanese exports. The BoJ's action has also sparked heated protests from trading partners who accuse the bank of initiating a currency war. The experts are waiting to see if Kuroda's floodgate strategy will touch off another round of competitive devaluation or, perhaps, capital controls. We'll have to wait and see. Here's more from Nomura:
"Today's news from the BOJ was highly significant and has broad implications for global asset markets. Much like QE1 and QE2 in the US, we expect that the impact of it could filter out through global assets. To put it crudely, the price of assets, in toto, is a function of the amount of money in the system, divided by the number of assets. Increase the numerator without comparably increasing the denominator and the price must rise. The skill, of course is estimating which assets, and by how much."
Sure, if you pump a bunch of cash into financial assets, then stock prices rise. That's the great lesson of the last four years, right? (three rounds of QE have pushed all three major indicies to record-highs) But what effect will Kuroda's bond-buying binge have on deflation? After all, some of QE's most strident critics have said repeatedly that increasing reserves at the banks will not boost demand, activity or growth. Here's how Nomura's chief economist Richard Koo sums it up in a recent newsletter:
"I worry that recent moves in the forex market have been driven solely by announcements regarding quantitative easing and not by the relative changes in actual money supply.
"This is an indication that many forex market participants remain unaware that the relationship between the money supply and the monetary base has since 2008 (and since 1990 in Japan) morphed into something very different to what the textbooks predict.
"Prior to these bubbles, base money and the money supply tracked each other almost perfectly across the industrialized world. Knowing one of these variables, it was easy to assume what had happened to the other. Since the bubbles burst, however, this relationship -- like the one between base money and inflation -- has collapsed.
"Behind the breakdown of both these linkages is the fact that the private sector, which is dealing with balance sheets impaired by the collapse of an asset bubble, has not only stopped borrowing but has also been paying down debt, prompting the money multiplier to turn negative at the margin at times.
"That is why central bank monetary policy has lost so much of its potency in Japan and other developed economies in the postbubble era." ("Koo on BOJ's massive QE," pragmatic capitalism)
This probably sounds more complicated than it is. What Koo is saying is that printing money doesn't do jack if there's no transmission mechanism to get it into the real economy. In other words, if the money gets hung-up in the financial system, all it does is push up stock prices, push down bond yields and inflate the value of myriad other goofball structured debt-instruments like MBS, CDOs, and ABS. Here's a couple charts from a post at Asia Confidential that help to explain what Koo is talking about:
"The velocity of money is one of the best indicators that deflation is getting the better of the Fed. Since the financial crisis, the Fed has flooded the economy with printed money, trebling the so-called monetary base. That base consists of highly liquid money, such as coins, paper money and commercial bank reserves with the central banks. US monetary base -- March 2013.
"Under normal circumstances, increasing the monetary base to this extent would be highly inflationary. But the problem is that this money is not making its way into the economy or changing hands (money velocity). That's why money velocity in the U.S. has dropped to a more than 60-year low.
"Rising money velocity indicates that the same quantity of money is being used for several transactions. It's turning over, signaling a robust economy. Declining velocity, on the other hand, indicates money isn't changing hands and that the economy is anything but healthy." ("Protecting Yourself From Japanese Insanity", Asia Confidential)
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