THE NOT SO INCREDIBLE SHRINKING YEN

4/9/13

When we last visited the issue of Japan’s attempts to reflate its economy at the behest of Prime Minister Shinzo Abe (See two posts from the now defunct Rant Finance written early this year and late last year that are reproduced at the end of this screed.), yours truly expressed great concern about this seemingly necessary but inherently dangerous policy.   Now that new Bank of Japan (“BOJ”) Governor, and Abe henchman, Haruhiko Kuroda, has fitted the printing presses at the BOJ with turbochargers that would make native son Speed Racer envious, the obvious results are coming to fruition; the yen hit a four year low against the dollar yesterday.

The obvious response would be something like “Well, what did Messrs. Abe and Kuroda think would happen if they publicly stated that their aim was to print yen with reckless, carefree abandon in an attempt to infuse the Japanese economy with what they consider a salubrious bout of inflation?   Did they think a policy designed to weaken the yen domestically would not have repercussions in the foreign exchange (“FX”) markets?”   But such a question would be naïve.  Both Messrs. Abe and Kuroda knew that the yen would weaken; that was, while not the primary object of their loose money policy, certainly a secondary object.  A weak yen would not only make Japanese industry “more competitive,” according to the textbooks, but also would help domestic prices to rise.

Such a policy is always dangerous, largely because it is hard to put the inflation genie back in the bottle and attempts to make one’s self “more competitive” by weakening one’s currency are doomed in anything but the short run.   (If a weak currency made a country more competitive, Zimbabwe would be the world’s economic juggernaut, but that is grist for another mill.)  But such a policy is, ironically, especially dangerous for Japan, whose primary economic problem for the last twenty or so years has been deflation. 

Japan has the highest debt/GDP ratio in the developed world at 220%.   Yet it still has the lowest government bond rates in the developed world; as I write this, the Japanese 10 year yields 0.53%, less than 1/3 the rate on the U.S. 10 year and less than ½ the rate on the German 10 year.  Part of this is due to Japan’s experiencing deflation rather than inflation and thus having real rates closer to being in line with those of its developed world counterparts than are its nominal rates.   But even on a real basis, Japanese rates are far lower than U.S. and German rates.   Why?   Because Japan’s gargantuan public debt is largely financed domestically due to the formerly enormous Japanese savings rate.   But, as I pointed out in my 12/19/12 post,  SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, the days of the 44% savings rate (That was in 1990, not in Cro-Magnon times.) are long gone; Japan’s savings rate is now around 2%, or the rate at which Americans declare that we have “deleveraged”…and then go back to our usual custom of excreting away money even faster than we earn it.   But I digress.  This decline in the Japanese savings rate is due largely to demographics; the Japanese population is getting older, and retired people tend to dis-save rather than save.   But it is also partially due to the infection of the Japanese psyche with the type of financial irresponsibility that is endemic to modern America.   Yet another case of our exporting our worst traits, but, again, I digress.

As yen are created by Mr. Kuroda and his subservient, to Mr. Abe, colleagues at the BOJ, Japanese investors pull their money out of yen denominated assets in order to protect themselves against the inevitable deterioration in the yen’s value both domestically and internationally.   This leads to further yen devaluation and starts a vicious downward spiral, further lessening the incentive not only for foreign investors to put money in Japan but, more importantly, for Japanese investors to keep their money at home.   This would be bad enough under any circumstance, but, in Japan, with its 220% public debt/GDP ratio, and which thus needs all the investment, both domestic and foreign, it can get, such a policy could be financial suicide.

The Japanese are very smart people, and one suspects, but can’t be sure, that  Mr. Kuroda nor Mr. Abe are not glaring exceptions to this rule.   However, one wonders how much Messrs. Kuroda and Abe have thought through this loose money, reflationary policy.   Sure, one must break the deflationary cycle and mindset in Japan.  But given the vulnerability wrought by the Japanese government’s inability to put its financial house in order, does the BOJ really have the latitude to so discourage people from financing the government’s debt?  Clearly, yours truly’s use of terms like “financial suicide” does not indicate that I would answer that question in the affirmative.

PROMISED REPRODUCED POSTS:

“I’M TURNING (AMERICAN) NOW!”

1/8/13

It seems that the same Japanese businessmen who were clamoring for a weaker yen now are concerned that new Prime Minister Shinzo Abe’s enthusiastic accession to their desires may be going too far.   The major fear of these captains of Japanese industry is the impact a too weak yen might have on imported energy prices, especially in the wake of Japan’s at least temporary denuclearization.

While the fears of these hard to please business titans regarding energy prices are justified, the larger fear ought to be the impact of a weak yen on the price and availability of imported capital.   As I explained in my 12/19/12 post, SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, and in earlier posts to which it refers, Japan has the largest government debt to GDP ratio in the developed world… 220%.   Until recently, this wasn’t much of a problem because, with the prodigious savings rate of the Japanese people, this debt could easily be financed internally.   But with demographics, and, to a lesser extent, attitudes resulting in a more Americanesque savings rate of about 2%, Japan increasingly has to import capital to finance, among other things, its government’s budget deficits.   A weakening currency, and a decided and declared government policy to further weaken a currency, does not get international lenders excited about committing capital to a country.  Thus, unless Japan’s political and business leaders put away the Econ 101 textbooks with all their drivel about “terms of trade” and abandon that great nation’s newfound weak yen policy, Japan could face severe financial problems in the very near future.

Yes, a nation finds itself in a precarious position when it must import much of the energy it consumes.   But if you think importing most of a country’s energy leads to problems, consider the more debilitating impact of importing most of a country’s capital.   And Japan will soon be in a position of importing both energy and capital in brogdingnagian quantities. 

Yikes!

SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!

12/19/12

The effective election of third generation Japanese pol Shinzo Abe as Prime Minister last weekend spells trouble for the Japanese central bank.  

To the extent people over here have followed the Japanese election, they have focused on Mr. Abe’s nationalistic foreign policy views.  His most immediate, and at least for now, largest impact, should be on the Bank of Japan (“BOJ”).  Mr. Abe is pushing for abandoning the JGB’s current 1% inflation “goal” in favor of a firm 2% inflation “target.”   He also wants the BOJ to go into the business of creating money to finance government spending.   Perhaps most important, he wants to legislatively chip away at the Bank’s independence so that a even a more reasonable future prime minister will feel less compunction about using the BOJ as an arm of the government.

Having the BOJ join its brethren central banks in the developed world in emasculating its currency would be especially dangerous for Japan.  Japanese government debt stands at 220% of GDP, the highest in the developed world, even if we look the other way and expand the definition of “developed” to include Greece.   As I explained in my 9/21/12 post, JGBs AND THE JAPANESE SAVINGS RATE, this condition has prevailed for years but has not been a problem due to Japan’s historical gargantuan savings rate…as high as 44% as recently as 1990.  With people saving at these prodigious rates, even Japan’s brobdingnagian deficits could be financed domestically.  But now, due to demographics and the importation of more American attitudes toward saving and postponement of gratification, the Japanese savings rate has fallen to levels with which Americans are familiar…around 2%.  Thus, Japan’s customary huge deficits must increasingly be financed overseas; indeed, foreigners now hold about 9% of Japanese government debt, a record.

With Japan having to sell a rapidly growing share of its debt overseas, it is imperative that the yen remain strong.  But with Mr. Abe’s pressuring BOJ President Masaaki Shirakawa to pursue a 2% inflation rate and print money so Mr. Abe can spend more and threatening the central bank’s independence, we are beginning to see a very non-Japanese posture toward the value of the yen.   This should have a decidedly negative impact on the ardor of foreign investors for holding Japanese government bonds (“JGB”s).   Predictably, JGBs have taken a beating in the few weeks since it has become apparent that Mr. Abe’s Liberal Democratic Party (“LDP”) would win the election and are now trading at an eight month high yield of 1.74% on the twenty year.

One could argue that the Fed’s pursuing an expansionary monetary policy very similar to the policy proposed by Mr. Abe has done nothing to hurt foreigners’ enthusiasm for treasuries, and we have to finance a much larger share of our government debt overseas.  But one would be wrong.    More than ¾ of Treasury issuance is now being purchased by the Fed; no one, Chinese, Japanese, or American,  is lining up to buy U.S. treasuries at the prevailing 1.79% yield on the ten year, especially when the reason that paltry yield prevails is the Fed’s creating money to finance the government’s spending.  We will be in for a rude awakening when (if?) the Fed decides to throttle back and we expect our Chinese and Japanese friends to pick up the slack.  If the Japanese adopt American attitudes toward central banking, as they have toward saving, they will face the same problem, but with twice as much government debt, relative to GDP, as we have.

“(BEN BERNAKE) CAN ‘CAUSE HE MIXES IT WITH LOVE AND MAKES THE WORLD TASTE GOOD…”

4/5/13

Much of the speculation in the financial media today centers on the reasons for today’s minor tumble in the stock market; as I write this, both the Dow and the S&P are down about 1%.  It seems that memories are short and, after the breathtaking, some of us think frightening, run-up in the stock market of late, even such minor stumbles becomes news.   Just a few years ago, a 1% down day would be cause for rejoicing on a relative basis.  But I digress.

The disappointing employment report is most often cited for today’s troubles in stocks.   Some are arguing that these mediocre numbers are the result of the dreaded sequester’s having finally reared its ugly head.   Those of us who have long questioned whether a 2.5% cut in federal spending can have any noticeable, let alone dire, impact on the economy are doubtful of this political statement disguised as market prognostication by people whose familiarity with the markets is akin to their familiarity with life outside the public payroll.  While trying to determine why the market does what it does on a day to day basis is nearly as perilous and pointless as trying to guess where it is going to go, it is fun and, for many, apparently profitable, to engage in such games.   If yours truly had to play this game, I would guess that the market is down today largely because it has been up so much the last several months and people are looking for an excuse to take profits.   The only item that somewhat rattles my confidence in that guess is that gold is up just short of 1% today, and I have long said that I won’t believe a market correction that is not accompanied by a run-up in the price of gold.   Of course, gold might be up simply because it has been taking a hammering for about the last six months.   See how dangerous, and silly, this stock prognostication game is?   Better to buy index funds and kindred products and rebalance religiously (See my 2/26/13 post CZAR BERNANKE’S DIKTAT:   BONDS MUST BE RICH, STOCKS MUST BE CHEAP), but, again, I digress.

Suppose, though, for a moment that the employment report was as tepid as it was because of the sequester.   This raises a frightening question:   What if the economy is indeed so fragile that a mere 2.5% cut in spending can derail it?   But this leads the fertile mind to an even more terrifying question:   If the economy, and presumably the markets, react like this to the damage done by the paltry sequester, what will happen when the massive monetary stimulus that has been the crack cocaine of this economy and this market is withdrawn?   Given the support the housing sector is getting from the fantasy land interest rates the fed has created, the break federal and state governments are getting on their interest payments, and the massive long positions our entire financial system holds in treasuries and mortgage backed securities, what will happen when rates start to approach reality if the markets and the economy can be thrown into a tizzy by the laughable attempt at fiscal restraint called the sequester?

This leads to a further question, one that I cited in my aforementioned 2/26/13 post.   We have put most of our eggs into the monetary basket, depending, as I just wrote, on the Fed for the low interest rate crack that keeps the economy going.    Is it healthy to put such power in the hands of Obsequious Ben and His Merry Men and his colleagues across the oceans?   I heard a St. Louis Fed official on Bloomberg radio the other day saying that there is no danger of a bout of inflation, or even asset bubbles, from massive injections of money into the system as long as the Fed has a credible (emphasis mine) plan for withdrawing that liquidity.  

There are two problems with this statement.   First, we are already seeing asset bubbles, certainly in treasuries (Again, the 2/26 post) and almost as certainly all along the risk spectrum in the bond market.   Too late for the Fed’s credibility to save the day in those markets. 

Second, how can the Fed have a credible plan for withdrawing its liquidity when, by all historical measures, the Fed should have no credibility whatsoever?   I heard Jim Grant make the point of CNBC a few weeks ago (I’d like to think he got the idea from reading my 2/26/13 post, but Jim, one of the most brilliant thinkers in finance today, or ever, probably doesn’t need even this insightful piece to come up with his ideas.) that we seem to put far too much credence in an institution that has a history of repeated failures.   Think G. William Miller’s inflation, Alan Greenspan’s mortgage and real estate bubbles, the Hoover era Fed’s deflationary monetary policy, etc.  

Mr. Grant, and yours truly, are absolutely right; we have clearly ascribed awe approaching credibility to an institution or, on a worldwide basis, institutions, that have not merited that credibility and respect.  Given the performance of the bond markets (though one wonders how they would be doing if the Fed weren’t buying about ¾ of net treasury issuance) and the stock markets (at least until today), the markets seem to think that the fed and its central bank colleagues are worthy of the enormous trust we have placed in them by placing not only monetary policy, but the very functioning of our financial system and our economy, in their hands.

This is indeed frightening.   But what might be more frightening is that some day the markets are going to sober up and realize that they have put their confidence in an institution that is in way over its head.   This is not necessarily a knock on Mr. Bernanke and his colleagues; it is simply an observation that the management of the functioning of the worldwide financial system is beyond the capability of any single institution or group of institutions; it is the business of the market, not monetary mavens and economic shamans ensconced in modern day temples of monetary munificence, to guide the world’s finances.  What will happen when the markets relearn this lesson?

For all I know, or anyone knows, by the end of the day the stock market indices could all have turned positive.   Speculation on this is pointless.  But the type of speculation that a day like today germinates is always fruitful.

FEDERAL SPENDING: MAKE THEM PAY!

1/26/13

In her weekly column in this weekend’s (i.e., Saturday/Sunday, 1/26-1/27/13) Wall Street Journal, Peggy Noonan makes the following statement in arguing against the fiscal policy of Barack Obama and for fiscal prudence:

“Some, especially those who are younger, do not fully understand that what is supporting them is actually coming from other people.   To them, it seems to come from ‘the government,’ the big marble machine far away that prints money.”

Under normal circumstances, Ms. Noonan would be right, as she usually is.   But these aren’t normal circumstances; in the Bush/Obama years, we have fallen down the fiscal policy rabbit hole.

The hole in Ms. Noonan’s argument is, ironically, highlighted in her description of the government’s being, in some people’s perceptions, a machine that “prints money.”   In the modern Bush/Obama approach to fiscal policy, 30 cents of every dollar spent is borrowed.   So nobody is paying for roughly one third of the government services that people are demanding or are otherwise being handed.   One could argue that we are paying the interest on the money borrowed, but, at today’s near historically low interest rates, the interest on the debt is negligible.   Wait until interest rates return to “normal” levels if you want to see truly brobdingnagian deficits, but I digress.

Speaking of low interest rates, they are low because the Fed has aggressively expanded the money supply and targeted interest rates in its never ending crusade against elderly savers in order to reward the spenders and borrowers who got us into the economic miasma from which the experts tell us we are emerging.  The major component of this effort is purchasing treasury and mortgage backed securities with money that the Fed creates almost literally out of thin air.  In fact, the Fed buys roughly ¾ of net treasury borrowing in such a manner.  

So…

We are borrowing about 30 cents of every dollar we spend.   The Fed, in turn, is providing, by money creation, 75 cents of every dollar we borrow.   So what we have is a monetary policy problem perhaps as large as our fiscal problem.  Indeed, the monetary problem is probably larger because without such vigorous and energetic cooperation from the Fed, the government could not borrow, and spend, so much money.

So…

Ms. Noonan, who would be right under normal circumstances, is only partially right in the brave new world of BushObamanomics.  No one is paying for a large measure of the government “services” that are being provided.   We are effectively getting government at a 30% discount.   Nothing drives up demand like discounted prices; no wonder the demand, from all points along the political spectrum, for government continues to grow!

If indeed we want to throttle the growth of government (and yours truly and Peggy Noonan surely do), we should make someone pay for the government we demand.   Then those who have to foot the entire bill might be inspired to offer some spirited resistance to those who demand more and more from government.   No one likes higher taxes, especially yours truly.  But perhaps a balanced budget amendment that would wind up requiring higher taxes when people demand more government might be the most effective means of checking the seemingly never ending expansion of the federal leviathan.  Nothing else has worked.