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The Rising Sun of Quantitative Easing--Bank of Japan Steps Up

Posted by Joseph Trevisani on Oct 31, 2014 3:22:00 PM

The Bank of Japan entered full monetary easing today in an attempt to shock the Japanese economy out of decades of deflation and economic stagnation. 

New stimulus measures announced by BoJ Governor Haruhiko Kuroda come as the campaign of Prime Minister Shinzo Abe's administration to end deflation and ignite economic growth seemed to be faltering with inflation and GDP figures dropping from their recent highs. 

The central bank said that it would purchase more shares of exchange traded funds and real estate investment trusts in an efforts to boost equity prices, extend the term of its portfolio of Japanese government bonds and speed up the rate at with it is expanding the money supply.  

Japan’s giant Government Pension Investment Fund said  it would increase its allocation of stocks, pumping trillion more yen into the stock market and the economy.

The fund, known by its acronym GPIF, said it would reduce its holding of Japanese government bonds and raise the share of its assets in Japanese and foreign stocks by more than 10 percentage points each. Ostensibly this would be to increase returns for Japan’s rapidly growing population of retirees, but its economic goal is to boost the Japanese equity markets and thereby create the same 'wealth effect' increase in domestic consumption that has been sought by the Federal Reserve’s quantitative easing policies in the United Sates.

In Tokyo, the Nikkei Stock Average jumped 4.8 % on heavy volume, bringing the index to its highest level since late 2007 and igniting a worldwide equity rally. Exchanges in Hong Kong, Shanghai and Mumbai were all more than 1 percent higher.

nikkei oct 31 min

nikkei 2 yr oct 31

The German, French and Spanish indexes gained more than 2 percent, the British more than 1 percent and in the US the Dow, S&P band NASDAQ soared 1 percent on the open with the Dow setting and all-time intra-day record. 

The yen fell as low as 112.49, its lowest level against the dollar since early 2008.

yen close 1 min oct 31

yen 2008 oct 31

The rapid devaluation of the yen will pressure central banks in Japan's trading partners from Europe to South Korea and most importantly China, to take steps to prevent the strengthening of their own currencies and the deterioration of their terms of trade with the world's third largest economy and one of its export powerhouses.

The weakening should give a quick boost to inflation by raising the cost in yen of imported goods and of imported commodities such as oil and gasoline. It will also decrease the price of Japanese goods on world market, hopefully boosting exports. 

The fall in the yen from around 80 to the dollar at the time of Mr. Abe's election in December 2012 to over 105 by January 2014 took annual inflation from -0.1 percent in December 2012 to 3.7 percent by May of this year. It has since fallen back to 3.2 percent. 

But that sharp yen devaluation failed to have much effect on the sales of Japanese exporters. Many Japanese manufacturers had shifted production to other Asian countries during the period of expensive currency and slow growth. The missing benefits of the weaker yen were one reason that some in the BOJ and elsewhere questioned the wisdom of relying solely on monetary policy to lift the economy without also instituting the type of economic reforms that would make the Japanese economy more productive and competitive. 

Bank officials had not intimated in recent weeks that any policy move was being contemplated. Perhaps that was because in discussions the bank governing board was more than unusually split on the nature and extent of the stimulus. Mr. Kuroda, who normally receives unanimous support from the policy board, cast the deciding vote himself in a 5-4 decision. Such a close vote is practically unheard of in the bank's history.  

With the new bond policy, the Bank of Japan will essentially be purchasing all of the debt issued by the national government. Even at the height of its bond purchasing, the Federal Reserve was assuming only 70 percent of the new U.S. government obligations. The program has since ended.

Japan is the most highly indebted government in the world, with total national debt over 200 percent of GDP. 

That dependence on the central bank to fund government deficits, divorcing the government bond market and the government deficit from the discipline of the open market raises many concerns.

First is that the BoJ is in essence underwriting the inability of the government to generate the kind of economic growth that produces revenue. Secondly that over time the use of deficit spending to prop up the economy without undertaking the far more difficult task of economic reform could undermine market faith in the stability of Japan’s public finances and ultimately the financial reliability of Japanese government debt.

Though the BoJ will be buying all newly issued debt, the central bank only owns about 40% of all the outstanding debt. If investors began to worry about viability of those securities, or their inflation adjusted return, increasing sales could conceivably drive Japanese interest rates much higher, vastly complicating the recovery actions of the government and central bank.

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

cpi japan oct 31

 

japan govt debt oct 31

 

 

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