Aggressive bond buying?
You call printing $75 billion per month out of thin air to buy U.S. Treasury bonds aggressive? Pu-lease! In the pool of central banks, our Fed definitely swims in the shallow end of the pool.
To find a shark, we have to look to across the Pacific. And it’s not China … it’s Japan.
Most central banks moan and groan about printing a few measly billion dollars or euros to buy bonds. Will the currency suffer too much? Will the markets remain stable? Will businesses use the lower interest rates to borrow cheap money for investment?
What whiners! They should all take a page out of the book currently being written by the Bank of Japan (BoJ).
Go Big or Go Home
Up until Friday, the BoJ was content to print 60 trillion to 80 trillion yen over the course of a year, spending roughly 50 trillion yen on their own government bonds. In dollars, this equates to printing between $550 billion to $720 billion, with about $450 billion spent on Japanese government bonds.
However, the straight up conversion to U.S. dollars doesn’t tell the whole story. Japan’s economy is roughly 30% the size of the U.S. economy, so their level of printing would equate to the U.S. pumping between $1.8 trillion and $2.4 trillion into the American economy each year, with $1.6 trillion used to buy U.S. Treasurys.
That’s a lot of cash, but as I said, that was the case until last Friday. Now, the BoJ is going to print even more.
The Japanese central bank announced its plan to print 80 trillion yen per year, using just about all of it to buy Japanese government bonds. This equates to about $730 billion dollars, and that would be like the U.S. printing $2.5 trillion per year to buy U.S. Treasurys.
That’s more than $200 billion per month, where our Fed was only printing $85 billion per month at the height of its quantitative easing (QE) programs.
Interest Rates and Bonds
The BoJ also stated their plan to triple the amount of yen they print to buy ETFs in their stock market, growing the program from 1 trillion yen to 3 trillion yen, or from $10 billion to $30 billion, per year.
Our Fed didn’t even (officially) get into the equity markets.
The goal of these programs seem obvious — to hold down interest rates by purchasing government bonds, and to prop up the stock market by purchasing ETF’s…. but there might be more to it.
On the same day that the BoJ announced these moves, the Japanese Government Pension Investment Fund (GPIF), which controls $1.2 trillion in assets, announced plans to sell $300 billion of Japanese government bonds, and buy $150 billion each of Japanese and foreign equities.
This might, just possibly, look like a coordinated effort to keep the price of Japanese bonds high (and rates low) while the GPIF reduces its position, and to boost the equity markets as the GPIF increases its holdings of stock.
Whatever the intention, this was exactly the result. Japanese bond yields fell even further on the news, with the 10-year bond yield dropping to 0.43%, while Japanese equities were up almost 5% on the day of the announcements.
But nothing in this world is free.
If it all sounds like sunshine and roses so far, that’s because we’ve only discussed the winners. The losers in this game are the Japanese consumers.
As the BoJ prints more yen, the value of the yen falls against other currencies. This is part of the goal — to make Japanese exports cheaper on the world markets in order to boost exports and increase Japanese GDP.
Starting in 2012, the BoJ has been driving the yen lower; since that time it has fallen from 78 yen to the U.S. dollar, to 109 yen to the U.S. dollar. That’s a 40% devaluation.
While this does make it cheaper for foreigners to buy Japanese goods, it also makes foreign goods more expensive to Japanese buyers. If we were only talking about importing Porsches and Caterpillar tractors that would be one thing, but Japan is a series of rocky islands.
They import much of their food and energy, which are two things it’s hard to live without. As the yen slides, imports of food and energy march higher in price. And it gets worse.
The Effects of a Dropping Yen
Part of the goal with driving down the yen was to increase Japanese corporate profits, which were supposed to trickle down to employees in the form of higher wages. It hasn’t happened. While some workers have received minimal increases, the extra money hasn’t been enough to offset the inflation in necessary items.
Most workers haven’t even received the minimal wage bumps. So as the yen drops, Japanese consumers watch their cost of living increase… as their wages remain mostly flat.
And since the government is using newly printed yen to buy bonds and hold down interest rates, savers can’t earn any interest, much less sufficient interest to offset their increased costs.
When the BoJ announced even more yen printing, the yen’s value fell from 109 per U.S. dollar to 112, so Japanese consumers immediately suffered a nearly 3% jump in the cost of imported food and energy in one day.
Oddly, equity markets around the world rallied as well. The European markets were up more than one percent, and U.S. markets posted similar gains.
The reasoning seemed to be that money will flow out of Japan, where it’s treated badly with a falling yen and low interest rates, and will make its way to other markets. But this seems to ignore the long-term implications of what is going on in Japan, and where it might lead.
What happens as the Japanese population continues to age and they’re left with assets like stocks that have profits on paper, but their currency has dropped so far that they can’t afford food and energy?
What happens when the world loses faith in the currency of the third largest economy on the planet because Japan, with a debt-to-GDP ratio of more than 240%, has chosen to run the money presses 24/7?
At some point, foreign investors will choose to hold zero yen, because the currency has become meaningless as the BoJ prints with abandon.
Japanese importers will have to pay all their bills in foreign currency. These two trends will mean the BoJ will have to spend down its foreign currency reserves as it exchanges dollars, euros, and whatever else it has for yen.
If the BoJ’s foreign currency reserves run low, the country runs the risk of becoming Argentina circa 1950.
The lesson for foreign investors is to keep the Japanese markets at a distance. If you have to be involved, make sure your currency exposure is hedged.
You don’t want to wake up one morning to find that your assets have fallen by 3%… 10%… or 20%… when the yen comes crashing down.
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