The Bank of Japan Reached the Limit of its Power

August 2 2016

The Japanese central bank, the Bank of Japan, has reached a point at which it has two options left: (a) make monetary policy even more extreme, with helicopter money, or (b) conclude that their Keynesian solution of loose, looser, loosest monetary policy has failed. Last week, Haruhiko Kuroda announced that the Bank of Japan will buy more ETF’s (yes, more, the Bank of Japan already buys index funds) and lend more dollars to Japanese companies with overseas business (yes, the Bank of Japan was also already doing that). But the market wanted helicopter money. The result? The Japanese yen strengthened almost 2% against the dollar. In other words, Kuroda will have no choice at his next policy meeting: either implement helicopter money and make his extreme monetary policy even more extreme, or admit that his extreme monetary policy has failed and loosen the reins.

Waiting for Inflation

It is a mere waiting for higher inflation. Not just in Japan, but also in Europe, and also in the United States. But the consumer price index (CPI) will not always hover around zero. Sooner or later (even core) CPI will rise and exceed 2%. In fact, core inflation is already above 2% in the U.S. But inflation in Japan is still lagging.

And then what?

Then the consequences will come to the surface. As long as inflation does not pick up, the Bank of Japan can buy all the Japanese bonds it wants. But as soon as inflation picks up, it is quite clear on whose shoulders the weight will fall of the unbearable Japanese public debt: the taxpayer’s. Or more specific: all holders of yen.

Inflation in this sense is nothing else than a tax. An unavoidable tax that is due after years of living on deficit spending.

Despite the fact that central bankers have the illusion that debt does not matter, history will once again demonstrate that debts have to be settled, one way or another.

The question that remains is: who is going to pay these debts?

Of course, there is no doubt that helicopter money would accelerate this process: inflation is more or less a given when bank account holders receive additional money. Whoever runs first to the store, can you this “gift” to buy products and services against the old price level. However, this higher monetary demand will lead to one thing and one thing only: a new, higher price level.

The first that runs to the store profits the most. This is a phenomenon French economist Richard Cantillon demonstrated, and something we nowadays call “Cantillon effects” in economic science. The incentive exists to, in case of helicopter money, to spend money and push prices up.

And then what?

Raise interest rates to fight high(er) inflation?

As you can now see, there is only one conclusion possible. Moreover, a conclusion that I have repeated on multiple occasions. The central bank is akin to a pyromanic firefighter. A firefighter that lights his own fire and consequently gets all the compliments for the good firefighting. He is a hero, as long as nobody figures out that he was the one who caused the fire.

The Japanese Central Bank Surrenders?

While the Bank of Japan is on the brink of surrendering, it appears Prime Minister Shinzo Abe is embarking upon the last inning of the game.

The central bank did not succeed in reaching what they set out to reach: higher inflation. Because higher inflation would put an end to all the economic suffering for good (a rather naïve thought). Since deflation, or a declining consumer price level, is our enemy number one, at least according to the Keynesians that dominate Japanese politics.

The central bank finds itself in a catch-22: when the Bank of Japan loosens monetary policy further, markets will expect and demand even more loosen monetary policy at the next meeting. And we are reaching a point where that more loosen monetary policy is getting frighteningly extreme, even for Japanese bureaucrats.

Because when you have tried everything, little is left to try. After marihuana, XTC, cocaine and heroin, damn few drugs remain to reach an even higher high. Methamphetamine, as analogy to helicopter money, but that might be a bit scary, even for our drug addicted Bank of Japan.

Or as a Japanese stock analyst expresses it: “What’s certain is that Kuroda has to do something extreme or unthinkable if he wants to surprise.”

Ironically, Ben Bernanke visited recently Japan to tell the Japanese what to do. Of course, Ben Bernanke knows one thing and one thing only: balance sheet expansion. So that was precisely what Ben Bernanke without any hesitance recommended the Japanese. And if that does not work, then certainly helicopter money must work.

For Keynesians it is never enough. If monetary expansion does not work, then it is because it “was not sufficient.” This is, of course, a plain fallacy. It is like a man or woman that is a pig-headed cheater and says he or she cheats because his or her partner does not give sufficient attention. Of course, it will never become clear how much is “sufficient,” just as Keynesians never make clear how much monetary stimulus actually suffices.

So now the government remains.

But Shinzo Abe announced an enormous fiscal stimulus package before the Bank of Japan announced its policy. Some thought that he did this, right at that moment, to put pressure on the central bank to make its monetary policy much more extreme. So what does Shinzo Abe´s stimulus package look like?

  • A total of $250 billion in fiscal stimulus
  • $90 billion in government spending on infrastructure (harbors, etc.)
  • Free hand-outs to Japanese lower-income citizens
  • Money for government corporate loans
  • And more…

In short, more of the same, in the hope that this time around it will lead to fortune.

In the meanwhile, the tension in forex markets is at its heights. The volatility in USD/JPY is as high as in 2008. Speculation in USD/JPY is beginning to resemble a football bet on the European Cup final.

This is the problem when governments and central banks play such large and decisive roles in economic decisions: every outcome is binary, and therefore leads to unprecedented volatility and price fluctuations.

While the Japanese are leading the race, the Europeans follow at a small distance. Here too, many will feel unsettled due to the higher volatility. But the fact that in Japan the yen is currently getting stronger despite desperate attempts of Shinzo Abe and Haruhiko Kuroda speaks volumes: the Japanese central bank is reaching the limits of its power.

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