Are we heading for a short sharp boom and a terrific final bust or a bust without a terrific boom, because there can be no middle ground? Or is Japan the Jack in the Box, a latent growth powerhouse ready to spring back from the dead?
The scale of the proposed Japanese central bank quantitative easing is mind blowing. Take all the expansion in the country’s monetary base since the start of time and do the same again in the space of 2 years.
I have been trying to figure out a way to pronounce on “the scale” of this move. Zero Hedge have commented If Japan’s “Shock And Awe” QE Happened In The US…., and so has Ambrose-Evans at the Telegraph, Japanese bank governor Haruhiko Kuroda makes history with monetary blitz, but I thought a recent Naked Capitalist Post, which does not mention it at all, provides the perfect backdrop: Fiduciary Duty to Cheat? Jim Chanos Reveals the Perverse New Mindset of Financial Fraudsters.
We may well be witnessing, with this unprecedented surge in money creation, a quasi financial fraud on a scale we have never seen before. Quasi in the sense that the BoJ is hoping to inflate asset values beyond their immediate net present value, regardless of the risks, in the hope that this will lead to more vigorous economic activity. The QE impact it intends is not merely a “portfolio effect”, but a vast reallocation of household and institutional portfolios from low risk to risky assets.
At the moment the monetary base is some 28.6% of Q4 2012 nominal GDP, having risen from some 8.4% in Q1 1994.
A doubling of the monetary base will raise it to 57.2% of Q4 2012 GDP. This is a galactic type increase in the monetary base, an increase which is likely to have perverse effects (and not necessarily positive) on Japanese financial asset valuations (and quite possibly global valuations) no matter how much of this money is eventually used for portfolio transaction purposes. To be truthful it is mind boggling, because where do we go from such a high level of monetary base and central bank liabilities if the gambit fails?
The Japanese central bank – Introduction of the “Quantitative and Qualitative Monetary Easing – says it is looking to raise inflation (a 2% target) when in reality it is more likely a) needed to support proposed government stimulus while keeping ongoing funding costs low and b) to facilitate a significant portfolio reallocation from low risk to risky assets.
I suspect the BoJ expects government stimulus on its own to fail to lead to lasting recovery, so to enamour it with an element of permanency the animal spirits are to be drugged and sent over the top.
GDP growth in Japan has been anaemic for some time and you could argue that even after allowing for factors such as declining population growth and necessary post 1990 private sector deleveraging, it has been growing below its potential.
But just how is quantitative easing going to stimulate domestic demand growth? We need rising wages and significant increases in (nominal) consumer debt:
And gross fixed capital formation (nominal) needs to rise:
All this at a time when Japan’s important long term positive trade balance has collapsed:
And lending to consumers, though rising, remains weak:
And to be frank, the economy has not had the income growth to support demand led growth and government expenditure clearly no longer has the legs:
Are we heading for a short sharp boom and a terrific bust or a bust without a terrific boom? Is the gesture simply too large and too late?
The one positive that I can see, is that the size of the monetary stimulus is sufficient to allow large amounts of JGBs to be sold to the central bank in exchange for funds for reallocation to the equity market and/or real estate market. This may well favour a short sharp boom followed by a terrific bust, because unfortunately the initial burst risks being too narrowly asset focussed.
But, it is the scale of the undertaking relative to the size of the problem that is the foremost of foremost concerns. I fear that we will need to see a pretty sizeable turnaround within a very short space of time and I fail to see how this is going to happen.