Of Interest


Saturday, April 20, 2013

Richard Koo essay on Japans BOJ Kaboda sans Qualitative Easing benefits and Dangers

The existing (and ongoing) massive expansion of base money into the banking systems of the US, England, and Japan is without precedent. As Nomura's Richard Koo notes, at 16x statutory reserves, the liquidity 'should' have led to unprecedented inflation rates of 1,600% in the US, 970% in the UK, and 480% in Japan.
However, it has not, yet. In short, Koo continues, businesses and households in these economies have stopped borrowing money even though interest rates have fallen to zero. And with no one borrowing money and many actually paying down debt, the money multiplier has turned negative at the margin - because of the severe damage caused to balance sheets when the bubble collapse drove asset prices lower while leaving debts intact (so-called balance-sheet-recession).
This suggests that there is little physical or mechanical reason for the BOJ’s easing program to work. But the program could also have a psychological impact - and Japanese media is on an 'inflation' full-court press currently. The risk here is that not only borrowers but also lenders will start to believe the lies. No financial institutions anticipating inflation could ever lend money at current interest rates. No actual damage will be done as long as the easing program remains ineffective. But once it starts to affect psychology, the BOJ needs to quickly reverse the policy and bring the monetary base back to 'normal'. If the policy reversal is delayed, the Japanese economy (and inflation) could spiral out of control.

Via Richard Koo, Nomura,
The Money Multiplier... and inflation...

The problem is - what if the people start to believe...
The risk here is that not only borrowers but also lenders will start to believe the lies. No financial institutions anticipating inflation could ever lend money at current interest rates. A financial institution that suddenly saw inflation on the horizon could not continue holding 10-year government bonds that yield 0.6%. The resulting rush to sell could trigger a crash in the JGB market, inflicting heavy damage on domestic financial institutions.

The question is how the Kuroda BOJ would respond to such a crash. If it began buying more JGBs, the monetary base would expand, stoking inflation concerns at a time when private demand for funds was already recovering and the money multiplier had turned positive at the margin.

But if the BOJ sold its JGB holdings in an attempt to quell inflation concerns, bonds would drop further, blowing a large hole in the balance sheets of financial institutions and the government.

By that time the monetary base could easily have grown to, say, 15 times statutory reserves. In that case the money supply would continue growing, causing inflation to spiral out of control, unless the central bank reduced the monetary base to about 1/15th of its current level.

I suspect that the BOJ would employ all the tools at its disposal to achieve this, including a sizable increase in the statutory reserve ratio, but all of those measures would serve to push rates higher, resulting in large losses for the BOJ and other JGBs investors.

And don't rely on 80 year old 'proof' since it is different this time...
Mr. Kuroda’s methods have frequently been compared to those of the 1930s-era finance minister Korekiyo Takahashi, who championed a successful policy of BOJ underwriting of government debt issues. But Japanese people in those days could not move money freely overseas. The authorities today need to be especially careful inasmuch as almost anyone can move funds abroad with a telephone call or a few clicks on a computer screen.
Be careful what you wish for...
No actual damage will be done as long as the easing program remains ineffective. But once it starts to affect psychology, the BOJ needs to quickly reverse the policy and bring the monetary base back to a level more in line with the value of statutory reserves.
If the policy reversal is delayed, the Japanese economy could spiral out of control at a time when base money equal to many times statutory reserves is sloshing around in the market.
Moreover, the act of scaling back the monetary base must be carefully calibrated so as to minimize damage to the JGB market. The BOJ, Ministry of Finance, and Financial Services Agency should also have contingency plans in place in the event that easing triggers a crash in the yen or the bond market.
Full article below...

"within a month or two the zeros start coming back"

In his essay above, Koo makes clear that Japan has LOTS of positive things to do yet
He is superb, one of the great economists of the world ... tho I realise he does not fit in to the dominant themes on my blog.
But Koo and his ideas ... including making sure that common working people are the ones benefited, with jobs and incomes ... are a good part of why Japan has never had a 'depression' since its giant market crash 23 years ago, and why Japan has remained an okay place economically.
What is missing from the above summary, is Koo's optimistic presentation of the other parts of the new Japanese government's programme, which Koo thinks could well succeed, and help to avoid the problems mentioned in this article, if they are implemented promptly.
Koo writes in his Nomura research piece given above:
« One concern is the fact that while the first pillar of Abenomics—monetary accommodation—is already being implemented, the second and third have been slow in coming. I think the base money supplied by the BOJ would come to life if the government announced an accelerated depreciation scheme for capital investment or a bold plan for deregulation of the energy sector.
The Abe administration therefore needs to present concrete proposals for the second and third pillars of its economic strategyas soon as possible.
Other options for the “second pillar” that are being discussed include policies to encourage business investment, such asinvestment tax breaks or accelerated depreciation schemes. If such measures succeeded in ending the private sector’saversion to debt, I think everything would start moving in the right direction at a time when interest rates were low and banks willing to lend.
The third pillar of Abenomics—structural reforms and deregulation—needs to provide the kinds of attractive investment opportunities that tend to be in short supply in a mature economy like Japan’s.Oft-mentioned candidates for reform and deregulation include energy, environmental businesses, and agriculture. I think policies aimed at achieving more effective use of urban land, enabling residents to live in larger homes for less money, would create significant new domestic investment opportunities.There are few city dwellers in Japan who do not want to live in larger homes. 
Yoshifumi Tachibana, 32, might be one. He recently bought an apartment worth 60 million yen (£478,782; $766,430) in central Tokyo.
“I was told I’d get the best mortgage rate if paid about 20% up front, so I did,” he says.
“Low interest rates were definitely one of the reasons for me to decide to buy my first home. I borrowed 47 million yen and I am on a 35-year repayment plan with an interest rate of 0.075%.
But despite such attractive rates, real estate agent Hidetaka Miyazaki says he has not seen an increase in the number of buyers and investors in the last 20 years, especially not in sub-urban areas.”
Any system of money whose survival depends upon perpetual credit expansion for consumption as a model is doomed. There is always a saturation point, a point where no matter how low the rate is no one can assume a pennies worth more. Fundamentally all credit is, is the pulling forward of future demand with the kicker of interest. Imagine if you will 100 year car loans, 500 year home loans...regardless of how far into the future you push things you still need a minimum cash flow in order to service the debt. While debt can be expanded infinitely in theory, cash flow cannot. Add to that the insidious nature of interest which compounds over time and has to be created by the same mechanism all money is created (loaned into existence) and it should be obvious to everyone (which its not) that the system we live under is doomed.
Japan is a tragic but shining example of the failure of Keynesian/Fisherism. 20+ years of propping up the crony banks and their crony pols and crats has yielded nothing but bankruptcy for the Japanese people. Sidenote: until recently most of the "borrowed" money that the JapGov pissed away came from the Japanese people via the Postal system.
Now the the JapGov is basically turning Japan into a Chinese protectorate. The Chinese gov must love that they can not only basically "buy" Japan" but that they can also buy out their foreign asset holdings cheap. i.e. the Chinese can "recycle" their toilet paper dollars via Japan's US asset holdings and at a song too.
I wonder how close the Japanese will grow to like the Chinese in the coming years?!             
If Japan was a horse it would be in a very rare and expensive Findus sausage roll by now ... and waaay past its use-by date.
bon appetite

No comments:

Post a Comment