Curious how Abenomics is progressing six months after its announcement? These charts courtesy of Diapason should provide a convenient status update.
And some accompanying thoughts from author Sean Corrigan of Diapason Commodities Management
So the new man at the BOJ, Harohiko Kuroda, has hit the ground running, announcing a package of wild monetary nostrums beyond even the imaginings of the most cynical, the nub of which will see him act to double the monetary base of Japan by buying (mostly, but not exclusively) government debt—with no restrictions as to maturity—to the tune of around 30% of current GDP.
Though much has been made of the fact that the new man will soon be outgunning even Ben Bernanke in relative terms, few have considered that the rate of increase will be less than that effected by the SNB, while the target value of ~60% of GDP will do no more than match that achieved by the supposed monetary guardians of the equally thrifty Swiss, so the move is not exactly unprecedented. So far – and we emphasize that the jury has by no means reached its final verdict in this case – Bern has not managed to ignite a domestic conflagration to ravage the foothills of the Alps, so it might just be that the Tokyo touchpaper turns out to be attached to a similarly damp squib.
That no-one has quite articulated what the policy is meant to achieve is, naturally, no impediment to the launching of this grand experiment. Testament to the inconsistencies which abound in the rationale proffered for it, we have the repeated injunction that what no-one wants is simply for prices to rise in the absence of higher wages and, at the same time, for employment to expand. Yet since the latter requires that either real wages fall in general, or at least that the rise in wages lags the rise in marginal product winnable by the firm paying them, it is neither clear how this can be so arranged nor what appreciable benefit will accrue if it does, save the hoary old one of transferring resources from
creditors to debtors – a process which, by further reducing real returns to savers, may actually contract the take up of goods and services, not expand it.
Implicit in this is the idea that the programme will continue to exert downward pressure on the external value of the yen (something of a hope that dare not speak its name since the adjustment seen to date is already starting to arouse the ire of Japan’s trading partners and competitors). But can we even say that this will prove to be a boon in the case of a resource-poor country trying to make of such inputs a quantum of value-added
products to be sold abroad in sufficient quantities to feed and heat itself? A look at the swings in Japan’s net external position over the past four decades of floating exchange rates is hardly reassuring as there seems to have been a broad correspondence between greater surpluses and a
stronger, not a weaker, real exchange rate, with the latter furthermore appearing more in the guise of effect rather than cause.
Setting aside the aggravated question of whether any good will come of it, it may be tempting to assume that such an aggressive use of the printing press will meet with little difficulty in raising the rate of consumer price rises to the talismanic figure of 2% per annum. But therein lies the rub, for there exists no possible means—whether theoretical or empirical—of knowing whether even this narrow goal can be attained, or indeed of estimating whether the BOJ will succeed in undershooting or overshooting it.
For the positivists among our readers, we would ask you to consider the gross instability displayed in the past by the multiples between the base and overall money—or between the base and banking credit—on the one hand and between money and turnover (‘velocity’, if you will) on the other.
As in so many other parts of the world, the period since the Lehman singularity has seen a dramatic change in the composition of Japanese money itself, marking a shift in the proportion between the inside (private, up 8%) and the outside (central bank, up 52%) components of the whole. There has also been a greater emphasis on money per se rather than on the credit for which it can often be substituted (M2 ex-M1 has eked out a bare sub-2% gain in the past 3 ½ years). Thus, since the latter part of 2008, the M1/MB ratio has fallen from 5.48:1 to 4.28:1, while that for M2/MB has dropped from 8.36:1 to 6.41:1 (these last two themselves a far cry from the peak of 13:1 once seen in 1992).
Nor is the gearing mechanism between the availability of money and the commercial activity to which it normally gives rise totally immune to a little slippage. Undergoing its first decline when Japan’s own bubble burst in the early 90s, the ratio between M1 and non-financial industry revenues declined from 8.9:1 to 6.9:1 in 1997 when, in the wake of the Asian Contagion, it dropped smartly, ultimately plumbing a depth of 2.8:1 during the succeeding Tech Bust. A minor recovery up until the GFC has long since reversed and the measure has again dropped to a new nadir of only 2.4:1 (similarly, over the last 15 years, the M2 ratio has fallen from 2.7:1 to 1.6:1 while the MB equivalent has plunged from 30:1 to 10:1).
All of this should serve to demonstrate that money is not just a matter of brute quantities, but also of preference and of individual circumstance. In Japan, people and private corporations have spent much of the last twenty years slowly transferring their liabilities to the state and building up their money and near-money holdings as they asset of choice. Thus, while bank capital leverage remains elevated (somewhere between 20-25:1, depending on the data set used) LTDs have been falling for two decades, from a pre-Bubble peak of 110% to the safety-first mid-50s characteristic
of the last few years. Corporate leverage, meanwhile, has undergone a similar marked decline with manufacturing industry total assets:net worth
shrinking from 320% to 225% over the past two decades, itself a creditable enough feat but one which has been far surpassed among non-manufacturing firms where the shock of 1997-98 has seen a breathtaking 675% gearing tumble to a far less perilous 285% at the end of last year.
To gain a further sense of the very different equation which applies there, not that total household financial net worth in Japan amounts to around Y1,200 trillion of which no less than 30% is held in the form of money per se (versus less than 2% in the US) while close to another 40% is held in time and savings deposits (as against 17% in the US). Beyond this, households dispose of around 8% in directly-owned credit instruments and a further sum equivalent to 35% in pension and insurance reserves which are themselves heavily invested in much the same mix of assets (NB: totals do not sum to 100 since we are comparing gross assets with net wealth).
What could happen, therefore, is that despite ‘Corroder’-san’s worst efforts to undermine the people’s faith in their own money, they remain as stoically unmoved as they have been these long years past. How such a deadening absorption might be accommodated in practice is that the banks to whom the Japanese trust so much of their wealth might themselves take the opportunity to book a few windfall gains – and simultaneously to reduce a truly inordinate capital risk – by swapping some of the Y425 trillion pile of government debt they have as an offset on the asset side of their balance sheets for the excess reserves the BOJ will be so feverishly working to create.
Conversely, households have barely 10% in equities and foreign claims in their personal portfolios, while their pension and insurance companies hold just over a fifth of their assets in this same form. On the other side of the ledger, mortgage debt amounts to no more than 16% of financial net worth, as compared with their American counterparts’ 23% play on the real estate market.
A sturdy panoply of protective holdings and/or obligations, the former of which would appreciate and the latter depreciate in real terms and so provide an offset as either the internal or external value of the yen declines, is not something with which the average Japanese is overly well endowed, it would seem. Moreover, with an elevated number of them aged beyond the point of being able to repair any damage suffered, it might seem that there are too few who will thrive if any of Kuroda and Abe’s monetary ‘arrows’ hit their mark. Indeed, if there actually exists any rare beast as a ‘wealth effect’ in Japan, it is likely to come with a bold, red minus sign attached.
Given this vulnerability, if one of these ill-advised projectiles manages to trigger a chain reaction, the consequences could be truly appalling given that Japan has long been operating well beyond the Bernholz threshold of potentially hyperinflationary public finance. Yet again this fiscal year, the fifth in succession, the deficit will yawn to and through 10% of GDP while revenues will cover barely a half of outlays and gross debt
will therefore soon stretch to 280% of pGDP.
Net new debt issues are currently being pencilled in at around the Y42 trillion mark a year and, with the BOJ scheduled to buy Y70 trillion p.a., it
might seem that JGBs offer a one-way bet even here, but with a current overhang of Y942 trillion as we write, the possibility is not to be overlooked that while the Bank may be comfortably able to mop up the new flow, it might have its work cut out if others decide to use its resting bid to get rid of some of their enormous existing stock of claims.
Prime candidates would be foreigners (with Y87tln to hand and steep currency losses to hazard), the banks (which, we have seen, hold Y425tln in government claims, of which Y360tln in JGBS per se), and insurance companies (with Y222 trillion in debt and Y184 trillion in JGBs & TBs combined). In its last concerted attempt at re-inflation, conducted in 2002-3, the BOJ briefly pushed up both the monetary base and overall M1 by around 30%. The response of prices was modest to say the least: CPI moved from -1.4% to +0.5% three years later. If the same thing were to happen again, all that would have been achieved would be to have introduced an unnecessary disturbance of the pricing structure between inland and foreign trade and, at the margin, between those living off current income and those reliant upon stored past income. Debt would, of course, have climbed inexorably skyward, as would the debt/nominal income ratio.
Conversely, let us not forget that in the comparable act of folly perpetrated by the BOJ when the old Bretton Woods system was collapsing in ruins in the dark days of 1972-3, the Bank allowed the monetary base to jump more than 40% YOY, while M1’s increase again touched 30% YOY. On that occasion, the reaction was anything but muted as CPI shot to a peacetime extreme of 25%YOY and general prices rose by 75% over the next four years.
For the record, the nominal 10-year bond yield then shot from 6.4%in late 1972 to 9.7% at the start of 1975 while its real counterpart crashed to minus 16%. A nominal capital loss of around a fifth on a bond bought at the yield lows, compounded by a monetary depreciation of around a third would have cost the hapless Japanese saver almost half his real nest egg.
Given this chastening experience, it hardly bears thinking about what the consequences might be for bond yields – and hence for everything one
discounts by means of them – if such an avalanche of monetary repudiation were to recur, so it definitely merits a quizzical twitch of the eyebrows to note that even amid the euphoria of Kuroda’s MOME (Mother Of all Monetary Easings), yields past the 10-year area did not push beneath their 2003 lows and, indeed, bonds at the longer end have so far left a juicy looking excess on the chart by rebounding from the initial spike lower no less than 50bps in the 30-year with vols at 10yr highs.
In the meanwhile, the remembrance that there are other things to life than Japanese government bonds has led to a widespread reallocation. Ever since the shift in emphasis was signalled in mid-November there has been a rush into Japanese equities, with foreigners buying a net Y5.65 trillion
and domestics lightening their own portfolios of foreign stocks to the tune of Y4.18 trillion in that time – something which only makes sense in the context of a falling Yen if these latter were bringing the cash home to buy their own market. Furthermore, from a level close to a 4-year low,
margin debt has doubled in the past five months, adding Y1.26 trillion along the way to stand at a 5- year high.
Even so, the TOPIX still lies 90% below its 1988 peak versus the S&P500 (as does the MSCI Japan compared to the World ex-Japan index) and is still
in the 8th percentile of its post-Asian Contagion range of the past 15 years, 12% from the lows and a good 25% off the mean. Given the structural underweighting here – and also, possibly, the thirst for something into which to rotate gains accrued in the US index – it is not hard to see this heading for its next objective.
Where that lies is much more of a supposition, but the charts suggest that if it can remain above 13,000, the index could advance as far as 17,500,
some 30% higher, though possible further yen losses of the order of 15% would halve those gains for unhedged foreign speculators. Though bearishness
on the Yen is elevated – risk reversals are decidedly positive and IMM spec longs were only exceeded during the culmination of the currency’s 2002-07, 30% TWI-basis slide – we might consider that the Sakakibara reversal saw that same measure fall 40% and that a similar move today – while
eliciting further howls of outrage from Japan’s neighbours – would take it back to that same 2007 cyclical low (one that marked the top of the speculative asset cycle, you might note).
Let us here introduce a note of caution, however. At the start of that same early-70s episode whose effects on fixed income were so devastating, stocks seemed to offer an avenue of escape as 1972’s monetary influx saw them rocket upwards by 130% in nominal and by 120% in real terms (and this despite a 33% jump in the Yen’s REER) in sixteen glorious months. Nemesis was not long in arriving, however, as the 1973/4 bear market erased almost the entirety of the gains in real terms in a calamitous 20-month slide, leaving the inflation-adjusted index back at the same level it had first touched fifteen years earlier. It would be another eleven years before the real peak was again exceeded in the surge to the Bubble’s rare fied summit. Thirteen years later, the outgoing tide of speculative optimism would again see it recede below that same mark, one we have again been wallowing below ever since the debacle of 2008.
Short term gains we may well continue to expect, but lasting, real gains? That is a far cloudier prospect to consider.
Source: Diapason Commodities