Wednesday, February 22, 2012

Japan gets serious about fighting deflation

This chart shows the Japanese Yen/US Dollar exchange rate since the beginning of last year. What stands out this past month is the sharp depreciation of the yen, which has dropped 5.1% against the dollar in the past three weeks. It's the result of the Bank of Japan undertaking serious intervention steps to weaken the yen, which reached an all-time high of 75.8 against the dollar last October.

Typically, forex intervention is not very effective at changing a currency's value, since most intervention is "sterilized" by monetary authorities. For example, one arm of the government sells its currency for dollars in order to weaken it, thus increasing the supply of its currency, but then another arm sells bonds in order to mop up the extra supply of the currency. With no net change in the supply of its currency, the intervention leads to only a temporary change in the currency's underlying supply/demand fundamentals.

But as the chart above shows, this time the Bank of Japan is working hard to make the increase in the supply of yen permanent, by dramatically increasing its bond purchases and paying for them with bank reserves. In the upper right hand corner of the chart you can see where this latest version of quantitative easing has caused bank reserves to jump by 76% in the year ending Jan. '12. Not only is the BoJ intervening to weaken the currency and pumping up the supply of bank reserves to expand the money supply, but the BoJ has also announced a formal inflation target of 1%. They are working hard to stop the yen from appreciating further—since that leads directly to increased deflationary pressures—and they are actively trying to get inflation to rise at least modestly, from the current zero to 1%. These efforts stand a good chance of working, since they have worked in the past.

The above chart also shows how the BoJ pursued its first round of quantitative easing by greatly expanding the supply of bank reserves from mid 2001 to early 2006. During this time the yen averaged 115 against the dollar, which is about 30% weaker than it is today. In addition, inflation rose from a low of -1.6% in early 2002 to a high of 2.3% in 2008 (a lagged response to easy money in prior years). In other words, that round of quantitative easing produced results. But then the BoJ reversed its quantitative easing, slashing bank reserves by 75% over the course of 2006. This tightening set in motion the yen's record-breaking 60% rise against the dollar, from a low of 124 in mid-2007 to an all-time high of 76 in late October '11.

The chart also shows the origin of the deflation that has plagued the Japanese economy for so long. That's in the middle portion of the chart where I've highlighted the fact that the BoJ allowed zero net expansion of bank reserves from 1990 through 2001. With policy so tight, it is no wonder that the yen rose from a low of 160 in 1990 to 110 by the end of 2000—an appreciation of 45%.

Bottom line: Japanese monetary policy has tilted decisively in favor of at least some mild inflation, and decisively against further deflation. This may improve the outlook for the economy—and I note in that regard that the Nikkei 225 index is up 12% in the past month—if only because it will likely result in a pickup in aggregate demand as money velocity rises. The yen is likely to depreciate further against the dollar, thus providing some support to a dollar that has suffered from significant weakness against most currencies in recent years.


Benjamin Cole said...

I hope the Fed follows suit.

The globe could use some boom years.

BTW, Milton Friedman, Alan Meltzer, John Taylor and Ben Bernanke have all told the BoJ to print more money, and lots of it.

Monetary bullishness is needed by the times.

Public Library said...

Went long CAD vs JPY just before this move.

Doesn't this beget the question, interventions of all kinds are simply folly. The Fed targeting inflation and providing forecasts will also prove folly.

It is the intervention that is the problem, not simply the wrong kinds of intervention.

We need to move back to a metals standard with private global instituions capable of coining money. The Federal Reserve is anti-constitutional.

It is too easy to predict the demise of the global money printing regimes. Question is really about when and how to protect yourself.

Public Library said...

And it looks like with all the global money printing, we will get to test the theory about oil prices and economic tipping points in the not so distant future.

Benjamin Cole said...


Except the USA might be shrinking its money supply.

See research by an outfit named Divisia.

And the ECB has been obsessed with inflation until very recently.

Only China and India are growing robustly and they are in fact expanding their money supplies.

David said...

I have just finished reading James Rickards excellent book, "Currency Wars: The Making of the Next Global Crisis". These actions by Japan and the description of them by Scott seem to echo some of the predicted possibilities by Mr. Rickards for the beginnings of the "Next Global Crisis".

If that is true and my understanding of Mr. Rickards predictions are accurate, it's hard for me to understand Scott's somewhat rosy tone regarding this news.

Just the fact that such dramatic action by the BoJ seemed necessary to them argues to me that it is anything but good news.

Which makes me wonder if I'm interpreting wrongly.

I'd be interested to know what Scott thinks of Mr. Rickards work and how it relates to this news.

Benjamin Cole said...

OT, but fun to think about.

Usually, we hear that inflation, or rather an increase in the rate of inflation, represents a shift in income and wealth from creditors to borrowers. Some people regard this as bad, although businesses and real estate developers are borrowers, as are (usually) homeowners.

The evil word "redistribution" is often used to describe the effects of inflation.

However, we use federal income taxes to pay off the national debt (payroll taxes finance the entitlement programs).

As has been endlessly repeated in right-wing blogs, rich people pay income taxes.

Ergo, an increase in the rate of inflation (and subsequent deleveraging) means the national debt is smaller, and less of a burden on the wealthy.

Indeed, monetizing the national debt through QE lifts the debt right off the shoulders of the wealthy, allowing them to spend on productive investments (or even larger mansions).

Scott Grannis said...

Inflating away the burden of debt is an extremely regressive form of taxation. It transfers wealth directly from the less affluent to the government. I regard that as sinful.

John said...

"It (inflation) transfers wealth directly from the less affluent to the government."

The less affluent have no wealth. They live hand to mouth.

I think the QE is probably necessary to replace the money taken out of circulation by corporations that park a total of $2 trillion on the sidelines.

The notion that there is a "non-interventionist" way of running an economy as well as an "intereventionist" approach. Economics isn't ecology. It wasn't here before humans created it. It's an intellectual construct. A contrivance.

marcusbalbus said...

debase your way to prosperity

Public Library said...


Your interpretation is correct and we are in a currency war. Call it what you want but when the worlds CBs print money hand over fist, it is a race to the bottom.

My silver lining is the more the Feds keep pushing this agenda, the sooner we will debunk their theories and dismantle the institution.

Junkyard_hawg1985 said...

"Inflating away the burden of debt is an extremely regressive form of taxation. It transfers wealth directly from the less affluent to the government. I regard that as sinful."

Well Said Scott!