Category Archives: Japan

JAPAN’S OUTLOOK `NEGATIVE’ S&P SAYS

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The blind leading the blind.

I thought S&P knew better.

Sadly, they remain deficit terrorists and part of the problem and not part of the answer for a world suffering from an acute shortage of aggregate demand.

*JAPAN’S OUTLOOK `NEGATIVE’ S&P SAYS
*S&P SAYS JAPAN FISCAL FLEXIBILITY HAS DIMINISHED

5y JAPAN SOV CDS moves from 85 mids to 87 / 90 market at the
moment

USDJPY spiked from 89.60 to 90.15 but has since recovered back to 89.70

JGB futures traded down -11c from the 3pm close after the announcement
but are only 3 cents weaker currently


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PIMCO on Japan

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>   
>   (email exchange)
>   
>   On Mon, Jan 11, 2010 at 9:43 AM, Wray, Randall wrote:
>   
>   This passage is particularly embarrassing:
>   Conventional wisdom holds that the most effective way to break a liquidity trap is with
>   fiscal policy, levering up and risking up the sovereign’s balance sheet to support
>   aggregate demand, when the private sector is delevering and de-risking. In general, we
>   have no quarrel with that. But what holds in general does not necessarily hold in
>   specific countries. And Japan is indeed an exception, because the central bank uniquely
>   has the ability to foster rising inflationary expectations, lower real long-term interest
>   rates, and a lower real exchange value for the yen, all keys to breaking out of her
>   liquidity trap.
>   
>   AND JUST HOW DO WE KNOW THAT??? THE BOJ HAS BEEN TRYING TO CREATE
>    INFLATIONARY EXPECTATIONS FOR 2 DECADES, WITH NO SUCCESS.
>   

Agreed.

And, of course the only risk associated with fiscal expansion is inflation which is what they are trying to accomplish.

If they think they have sufficient public goods and services and want domestic consumption and a shift towards inflation, the direct route of cutting domestic taxes, particularly on the lower income groups, will do the trick very quickly.

Someone ought to do the world a favor and tell them it’s up to the MoF and not the BoJ.

With global growth accelerating in the second half of 2009, policymakers and investors alike naturally turned to discussion and debate regarding central bank exit strategies from the extraordinary, conventional (near-zero policy rates) and unconventional (Quantitative/Credit Easing) accommodation needed to prevent the Great Recession from turning into Depression 2.0. Two key questions dominate: the how of exits and the when of exits.

The Federal Reserve has been exceedingly careful to distinguish between these two questions, providing detailed public discussion of the mechanics of exit, while stressing that economic fundamentals, notably below-target inflation in the context of huge resource slack, particularly labor markets, imply there is no urgent need to implement any exit for an extended period. Other central banks have provided similar guidance, with one major exception, the Bank of Japan (BoJ). And the reason is simple: Japan remains stuck in a deflationary liquidity trap, implying that not only would it be fundamentally wrong for the Bank of Japan to pull back from extraordinary accommodation, but that it should be even more extraordinary.

Thus, we were pleasantly surprised in December that the Bank of Japan publically acknowledged that it would “not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent.” The BoJ’s path to anti-deflation redemption must start somewhere, and simply stating that its comfort zone for inflation does not include zero is a start. The fact of the matter is that the BoJ is trapped in a deflationary lacuna of its own making and can escape if it is willing to do the opposite of what central banks in other developed countries will eventually do in the matter of exit strategies. Simply put, the Bank of Japan needs to credibly commit to not exiting reflationary policies, even as other central banks proceed along that course.

Japan’s Liquidity Trap
An economy enters a liquidity trap when the monetary policy rate is pinned against zero, yet aggregate demand consistently falls short of aggregate supply potential. Such a state of affairs generates enduring economic slack, which in turn generates enduring deflation. That was a very real global risk a year ago, but was met head-on by BoJ’s sister central banks, in particular the Federal Reserve, whose mantra was “whatever it takes.” And while a relapse toward the fat tail risk of global deflationary pressures certainly still exists, that tail has been dramatically flattened by innovative, courageous, and explicitly reflationary policies. Not so for Japan, unfortunately: The country has been in a liquidity trap for almost two decades, with nominal GDP hovering near the levels of the early 1990s. And with a current output gap of 7-8% of its GDP, Japan faces perpetual deflation, unless and until the BoJ walks the reflationary walk.

To be sure, there are many, particularly in high-level policy positions in Japan, who argue that there is nothing more reflationary the BoJ can do, because the country’s liquidity trap is not a temporary one but rather a permanent one. The irony of the argument is that if it is followed, it is guaranteed to be “right,” or at least appear that way, as deflationary expectations remain entrenched and self-feeding. Yes, we recognize that Japan faces unique structural problems, most notably declining demographic growth. But neither in theory nor in practice does such a problem pre-ordain a permanent liquidity trap. It can be broken, if the BoJ were to become willing, in the famous words of Professor Krugman, to act responsibly irresponsible relative to monetary policy orthodoxy.

Conventional wisdom holds that the most effective way to break a liquidity trap is with fiscal policy, levering up and risking up the sovereign’s balance sheet to support aggregate demand, when the private sector is delevering and de-risking. In general, we have no quarrel with that. But what holds in general does not necessarily hold in specific countries. And Japan is indeed an exception, because the central bank uniquely has the ability to foster rising inflationary expectations, lower real long-term interest rates, and a lower real exchange value for the yen, all keys to breaking out of her liquidity trap. Yes, fiscal authorities in Japan can lever the sovereign’s balance sheet in a fashion that would make Keynes blush, but unless the monetary authority rejects orthodoxy, explicitly promising not to exit from reflationary policy, fiscal authorities’ stimulative efforts will be muted.

Krugman/Bernanke’s Prescriptions
Bank of Japan officials suggest that there is not much monetary policy can do, as evidenced by these comments in the minutes of its policy meeting on November 19-202 (our emphasis):

“A few members were of the opinion that the Bank should explain clearly to the public that the underlying cause of the continued decline in prices was the slack in the economy – in other words, the weakness in demand. These members added that to improve the situation it was essential to create an environment whereby final demand – specifically, business fixed investment and private consumption – could achieve self-sustaining growth, and for this purpose it was most important to alleviate households’ concerns about the future and underpin firms’ expectations of future economic growth.”

To be sure, there are indeed structural solutions besides resolutely reflationary monetary policy that would be helpful. For example, supply-side measures including increased immigration and child care facilities would be very helpful to mitigate Japan’s demographic trend. Likewise, a more flexible labor system would allow corporations to more quickly adjust employment to the levels sustainable in the New Normal, and allow them to invest for new opportunities emerging in Asia. Concurrently, accelerating Economic Partnership Agreements (EPA) would allow Japan Inc. to further benefit from Asia’s economic growth and to remain competitive. And the list goes on and on. So the BoJ does have a point: There needs to be many hands on the policy tiller.

But none of the non-monetary actions offers scope for what matters most: Breaking the private sector’s self-feeding deflationary expectations, while generating aggregate demand above the economy’s supply-side potential, lowering the output gap. Indeed, some desirable supply-side structural reforms would, on a cyclical horizon, actually increase the output gap. The unavoidable conclusion must be that reflationary monetary policy must be the workhorse to pull Japan out of its liquidity trap. For such an approach to be effective, it explicitly must not have an exit strategy, but the opposite: a promise to keep on keeping on, resisting all entreaties to pull back until inflation itself, not just inflationary expectations, is unleashed on the upside.

To its credit, the BoJ did adopt a commitment approach when it adopted Quantitative Easing (QE) in 2001, explicitly committing to a continuation of that regime until year-on-year change in the core CPI became positive in a “stable” manner. But when for a few months it appeared that “success” had been achieved in 2006, the BoJ exited QE. Whether or not it was a matter of a genuine policy mistake, made with the best intentions, or a policy mistake borne of a lack of will to be enduringly unorthodox is an open question. But the fact of the matter is that Japan slipped back into deflation soon thereafter. The missing ingredient was a commitment to not only resist pulling back from QE and avoiding rate hikes until inflation turned positive but to continue that policy even after inflation started moving up. And in terms of credibility, the cost has been high: Unless and until the BoJ commits credibly, backed by money-printing actions, to behaving “irresponsibly relative to orthodox, conventional thinking,” Japan will remain stuck in a liquidity trap.

If the BoJ needs academic footing to do what needs to be done, it could well follow then-Fed Governor Bernanke’s 2003 suggestion: Rather than targeting the inflation rate, the BoJ could target restoring the pre-deflation price level, meaning that deflationary sins are not forgiven. This way, Mr. Bernanke argued, the public would view reflationary increases in the BoJ’s balance sheet and the money stock as permanent, rather than something to be “taken back” at the earliest orthodox opportunity.

The BoJ: Time to Act Aggressively
Japan’s problem is deflation, not inflation as far as an eye can see. An “all-in” reflationary policy is what is needed.

Three concepts the BoJ could consider:

1. Explicitly promise there will be no exit from QE and no rate hikes until inflation is not just positive, but meaningfully positive. One way to do this would be to adopt a price level target rather than an inflation target, embracing the idea that past deflationary sins will not only not be forgiven but require even more aggressive reflationary atonement.

2. Buy unlimited amounts of the long-dated Japanese Government Bonds (JGBs) to pull down nominal yields, with an accord with the fiscal authority to absorb any future losses on JGBs, once reflationary policy has borne its fruits, generating a bear market in JGBs.

3. Working with the Ministry of Finance, sell unlimited amounts of Yen against other developed countries’ currencies, printing the necessary Yen.

Our read is that the BoJ has not concluded that such bold steps are required. But as Mr. Bernanke intoned,3 no country with a fiat currency, which borrows in its own currency in the context of a current account deficit, should ever willingly embrace deflation. It is to be fervently hoped that the Bank of Japan’s rhetorical reflationary thaw of December, declaring it will not “tolerate” zero or below inflation, will give way to active reflationary green shoots by spring.

Meanwhile, markets don’t wait. And if it becomes clear that the BoJ really does “get it,” the currency markets will be way out in front of the BoJ.

Paul McCulley
Managing Director


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Evans-Pritchard Telegraph article

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There is no operational support for this scenario. Comments below:

Global bear rally will deflate as Japan leads world in sovereign bond crisis

By Ambrose Evans-Pritchard

Jan. 5 (Telegraph) —

Weak sovereigns will buckle. The shocker will be Japan, our Weimar-in-waiting. This is the year when Tokyo finds it can no longer borrow at 1pc from a captive bond market, and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time. Every auction of JGBs will be a news event as the public debt punches above 225pc of GDP. Finance Minister Hirohisa Fujii will become as familiar as a rock star.

With non convertible currency this makes no sense. If deficit spending does generate excess demand and inflation short rates will rise if markets anticipate BOJ rate hikes as a BOJ reaction function to inflation.

Once the dam breaks, debt service costs will tear the budget to pieces.

That statement has no operational meaning. All payments in yen, dollars, sterling, etc. Are met in one way only- changing numbers upward in member bank reserve accounts. Operationally there is no ‘financial stress’ associated with this process.

Yes, excess deficit spending can cause the currency to fall and inflation, but to get out of a hole first you have to stop digging, and right now the currency is strong and deflation continues as the main concern.

The Bank of Japan will pull the emergency lever on QE.

A non event, apart from somewhat lower term rates.

The country will flip from deflation to incipient hyperinflation.

Not from QE. There is no channel from QE to the real economy, lending, or anything of consequence apart from (modestly) lower term rates.

The yen will fall out of bed, outdoing China’s yuan in the beggar-thy-neighbour race to the bottom.

Yes, excess deficit spending can cause the yen to fall and inflation to increase via the import/export channels.

By then China too will be in a quandary. Wild credit growth can mask the weakness of its mercantilist export model for a while, but only at the price of an asset bubble. Beijing must hit the brakes this year, or store up serious trouble. It will make as big a hash of this as Western central banks did in 2007-2008.

China will also reach political limits only when inflation becomes a political problem.


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Banks Given 10 Years To Meet Tougher Capital Rules – Tokyo

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Capital ratios control permissible leverage which initially appear to control bank returns on equity, but longer term spreads adjust and the roe gravitates to a bank’s cost of capital.

And since higher leverage increases risk to investors, the cost of capital eventually adjusts to the capital ratios, so over time- in the long run when we’re all dead to quote Keynes- it all comes down to about the same thing.

With markets discounting the near term a lot more than the long term it makes sense lower capital ratios will help bank equities.

>   
>   FYI – FSA just stated no agreement has been reached yet.
>   

*JAPAN’S FSA SAYS NO AGREEMENT TO EXTEND RULE IMPLEMENTATION
*JAPAN’S FSA SAYS INTERNATIONAL TALKS ON CAPITAL RULES ONGOING
*JAPAN BANK REGULATOR SAYS `NO TRUTH’ CAPITAL AGREEMENT REACHED

By Shingo Kawamoto
Dec. 16 (Bloomberg) — Japan’s Financial Services Agency
says no agreement has been reached on delaying new rules on
capital adequacy for banks. Motoyuki Yufu, a spokesman for the
regulator, spoke after the Nikkei newspaper reported
international banking authorities agreed to start introducing
new capital adequacy rules from 2012, giving lenders a
transition period of 10 to 20 years to implement the
regulations.

>   
>   Based on article below this transition period could potentially apply to
>   all banks and not just Japanese banks
>   

Banks Given 10 Years To Meet Tougher Capital Rules

TOKYO (Nikkei)- Global banking regulators have agreed to effectively delay the enforcement of new capital adequacy rules for large banks, opting to create a transition period of at least 10 years, The Nikkei learned Tuesday. The Basel Committee on Banking Supervision, made up of the banking authorities of major countries, has been discussing introducing stricter capital requirements since September 2008 in an effort to prevent a recurrence of the global financial crisis.

The proposed changes include raising the 8% minimum capital ratio banks are currently required to maintain and focusing on a narrower definition of core capital. The committee will stick to its plan to gradually introduce the new rules starting in 2012, but will establish a transition period of 10-20 years. This means that the rules will not be fully implemented until at least the early 2020s.

Banking authorities have apparently determined that a rush to adopt stricter requirements might deter lending by major banks and hurt the chances of a recovery in the global economy. “The Basel Committee has turned to a more cautious approach,” says a financial regulatory official in Japan. The committee will also consider allowing banking regulators in each country or region to decide when to fully adopt the new requirements. The slow phasing in of new capital rules will come as good news to Japanese banks, which had faced the prospect of being forced to bolster their capital through the issuance of common shares.

The Basel Committee plans to compile an outline of its proposals before the end of this year and roll out a concrete plan sometime next year.
(The Nikkei Dec. 16 morning edition)


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Gvt Risks Credibility By Ignoring Yen

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Buying $ is off balance sheet deficit spending and the easiest avenue politically.

If anything I am surprised they let it go this far. Their history of their economic model has been
to buy $ to support exports rather than cutting taxes to support domestic private sector demand.

On Thu, Nov 26, 2009 at 6:02 PM, Sean wrote:

This is the thinking that is going to really hurt Japan. The govt
fixation on freezing spending and relying on the BOJ to end deflation.
The yen is surging and according to the steelmakes lobby and automakes
“suffocating” them. The banks are bankrupts with the Nikkei below 7000
which means it will get there as everyone tries to reduce cross held
shares and hedge. In the past the govt bought prefrerred shares and BOJ
bought equities to ease the cross held share issue. The Nikkei
recovered and the banks survived. There doesn’t seem to be any
understanding of the problems or willingness to increase the deficit to
address what problems they do see.

OPINION: Government Risks Credibility By Ignoring Yen

TOKYO (Nikkei)–As the yen climbs higher, the real danger lies in
Japanese policymakers’ utter lack of readiness.

The U.S. Federal Reserve Board has signaled a continuation of its
near-zero interest rate policy, which is fostering a booming dollar
carry trade. Gold prices are breaking records almost daily. And the
yen’s ascent to a 14-year high in Tokyo trading Thursday is another
manifestation of the dollar-selling tide.

Why is the yen attracting buying when Japan’s economy is stuck in low
gear and its stock market is performing worst among its peers? There are
a few reasons. Some Japanese short-term interest rates now exceed U.S.
rates. Moreover, unchecked deflation has given Japan loftier real
interest rates than the U.S., a fact that investment funds have been
exploiting, says Nomura Holdings Inc. President Kenichi Watanabe.

Interest-rate-driven yen-buying has nothing to do with Japan’s
fundamentals. An appreciation of the yen above and beyond the strength
of the economy threatens to cripple domestic firms just starting to
recover. Such concerns are encouraging selling of Japanese stocks even
as U.S. and European shares regain strength.

The bigger problem is Japanese authorities’ indifference to this risk.
Leave aside Finance Minister Hirohisa Fujii, who has backed away from
statements early on in his tenure that suggested an opposition to
currency market interventions. Even if he did flash the intervention
card, the market would see right through his bluff.

Deputy Prime Minister Naoto Kan, who also holds the economic policy
portfolio, has owned up to Japan’s deflation but has yet to prescribe a
remedy for it.
The government’s only accomplishment has been to freeze
2.9 trillion yen in spending in the fiscal 2009 supplementary budget. In
a budget-vetting frenzy, it has failed to chart a course for
macroeconomic policy.

Beating deflation requires monetary policy. The Bank of Japan has
decided to end its purchases of corporate bonds and commercial paper.
That gives the impression it is hurrying toward the exit from loose
monetary policy.

Meanwhile, companies are holding down wages, cutting jobs and relocating
not only production but R&D overseas.

A runaway yen hollowed out Japanese manufacturing in the 1990s. Now,
policymakers who refuse to face the facts are beckoning on another
hollowing that might kill the economy.

The dollar’s decline is a global phenomenon, and the yen’s appreciation
is its flip side. Nevertheless, Japan’s economy is sustaining the
heaviest damage of all. If it continues to ignore the situation, the
government will risk losing the trust of the financial markets.
–Translated from commentary by senior Nikkei staff writer Yoichi Takita
(The Nikkei Nov. 27 morning edition)


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Richard Koo: a personal view of the macroeconomy

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I agree, and the deficit of consequence isn’t that high as I think that figure includes the TARP funds
which were a form of regulatory forbearance and not spending.

Unfortunately, elsewhere he falls short in explaining why deficit spending doesn’t have the downside risks the mainstream attributes to it.

Send him a copy of the 7 deadly innocent frauds draft for comment? (attached)

Richard Koo: a personal view of the macroeconomy

US a mirror image of Japan 15 years ago

In the last two weeks, I made my annual fact-finding mission to
Washington and also spent time in Boston and San Francisco. What I
witnessed was very reminiscent of the situation in Japan 15 years ago:
people were latching on to isolated fragments of good economic news as
evidence of recovery while ignoring the steady deterioration in the real
economy.

In addition to meetings with officials from the Federal Reserve and the
White House, I had the opportunity to talk with various groups at the
Hill including two Congresspersons over lunch.

Although there have been signs of improvement in the real economy,
particularly in production, the problems in the jobs picture are
underscored by the unemployment rate’s rise into double digits.

And on a personal level, the San Francisco bank that my parents
patronized for many years was shut down by the FDIC last Friday. To
prevent panic, the bank opened for business as usual on Saturday under
the name of another lender. This event added a personal dimension to the
crisis for me.

Budget deficit concerns make new fiscal stimulus all but impossible

One issue of particular concern on this trip was that people seem to be
paying little attention to the economic impact of the Obama
administration’s fiscal stimulus and instead are focusing entirely on
the size of the resulting budget deficit.

With the government running a deficit equal to 10% of nominal GDP, more
people are looking at the continued weakness in the economy:
particularly in employment: and drawing the conclusion that the
administration’s policies are ineffective and should be discontinued as
soon as possible. This view is so strong that additional fiscal stimulus
is seen as being almost impossible to implement today.

This pattern mirrors events in Japan 15 years ago. The more the
government draws on fiscal stimulus to avert a crisis, the more
criticism it receives.

People are giving no thought to the economic consequences if the
government had not responded to the $10trn loss in national wealth (in
the form of housing and stock portfolios) with fiscal stimulus. Instead,
they focus entirely on the fact that the economy has yet to improve
despite $787bn in expenditures.

In Japan, fiscal spending succeeded in keeping GDP above bubble-peak
levels despite the loss of Y1,500trn in national wealth, or three years
of GDP, from real estate and stocks alone. But because disaster was
averted, people forgot they were in the midst of a crisis and rushed to
criticize the size of the resulting fiscal deficits.

Their criticism prevented the Japanese government from providing a
steady stream of stimulus. Instead, it was forced to adopt a stop-and-go
policy of intermittent stimulus: each time a spending package expired,
the economy would weaken, forcing the government to quickly implement
the next round of stimulus. That is the main reason why the recession
lasted 15 years. And the mood in Washington today is very similar.

R. Koo


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Short-Rate Thoughts: DEFLATION – Radical Thesis Turnaround

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Well stated!

*Not house view.

Since March I have been arguing that the world was a better place than people thought. I am now shifting my core view, which still might take several months to develop in the marketplace.

Skipping to the Conclusions

1. Deflation will be the surprise theme of 2010, when Congress will go into a pre-election deadlock; elections have only underscored this is the public direction

2. Excess Reserves will neither generate new lending nor generate inflation; actually, the quantity of reserves (M0) basically has no real economic effect

3. ZIRP and QE actually CONTRIBUTE to the deflation mostly by depriving the spending public of much-needed coupon income

4. When Federal Tax Rates increase in 2011 this problem will become even more severe

5. The overall level of public indebtedness (vs GDP) will not put upward pressure on yields in this backdrop and there will be a reckoning in the high-rates/deficit hawk community

6. Strong possibility that QE will actually be upsized next year rather than ended when the Fed observes these effects (and this might actually make things WORSE)

The Explanation (a Journey)

It seemed fairly intuitive and obvious for thousands of years that the Earth was at rest and the Sun moving around it. Likewise, it has seemed that the Fed controls the money supply, balances the economy by setting interest rates and fixing reserves which power bank lending, that more Fed money means less buying power per dollar (inflation), that the federal government needs to borrow this same money from The People in order to be able to spend, and that it needs to grow its way out of its debt burden or risks fiscal insolvency. I have, in just a fortnight, been COMPLETELY disabused of all these well-entrenched notions. Starting from the beginning, here is how I now think it works:

1. The first dollar is created when Treasury gives it to someone in exchange for something ammo, a bridge, labor. It is a coupon. In exchange for your bridge, here is something you or anyone you trade it with can give me back to cover your taxes. In the mean time, it goes from person A to person B, gets deposited in a bank, which then deposits it at the Fed, which then records the whole thing in a giant spreadsheet. Liability: One overnight reserve/demand deposit/tax coupon. Asset: IOU from Treasury general account. Tax day comes, Person A pulls his deposit, cashes in the coupon, the Treasury scraps it, and POOF, everything is back to even.

2. For various reasons (either a gold-standard relic or a conscious power restraint, depending who you ask), we make the Treasury cover its shortfall at the Fed and SWAP one type of tax-coupon (a deposit or reserve) for another by selling a Treasury note. Either the Fed (in the absence of enough reserves well get to this) or a Bank (to earn risk-free interest) or Person A (who sets a price for his need to save) is forced out his demand deposit dollar and into a treasury note at the auction clearing price. What about the fact that treasuries aren’t fungible like currency? On an overnight basis, that doesn’t really constrain anyones behavior. A reserve or a deposit means you get your money back the next day. Same thing with a treasury. Functionally its cash and wont influence your decision to buy a car. Likewise for the bank. In the overnight duration example, it does NOT affect their term lending decisions if they have more reserves and few overnight bills, or more bills and fewer reserves. Its even possible to imagine a world (W. J.Bryans dream) where the Fed, with its scorekeeping spreadsheet, combines the line-items we call treasuries and reserves.

3. Total public sector dissavings is equal to private sector savings (plus overseas holdings) as a matter of accounting identity. This really means that the only money available to buy treasuries came from government itself (here I am being a bit loose combining Tres+Fed), from its own tax coupons. If there arent enough ready coupons at settlement time for those Treasuries, the Fed MUST supply them by doing a repo (trading deposits/coupons for a treasury by purchasing one themselves at least temporarily). They dont really have a choice in the matter, however, because if the reserves in the banking system didnt cover it, overnight rates would go to the moon. So in setting interest rates they MUST do a recording on their spreadsheet and the Fedwire and shift around some reserve-coupons (usable as cash) for treasury-coupons (usable for savings but functionally identical).

4. Thus monetizing the deficit is actually just the Feds daily recordkeeping combined with its interest rate targetting, just keeping the score in balance. However, duration is real, as only overnight bills are usable as currency, and because people (and pensions!) need savings, they need to be able to pay taxes or trade tax-coupons for goods when they retire, and so there is a price for long-term money known as interest rates. The Fed CAN affect this by settings rates and by shifting between overnight reserves, longer-term treasuries, and cash in circulation. When the Fed does a term repo or a coupon sale, they shift around the banking and private sectors duration, trading overnight coupons for longer-term ones as needed to keep the balance in order.

5. But all this activity doesnt influence the real economy or even the amount of money out there. The amount of money out there dictates the recordkeeping that the Fed must do.

6. This is where QE comes in to play. In QE, aside from its usual recordkeeping activities, the Fed converts overnight reserves into treasuries, forcing the private sector out of its savings and into cash. This is just a large-scale version of the coupon-passes it needed to do all along. Again, they force people out of treasuries and into cash and reserves.

7. The private sector is net saving, by definition. It has saved everything the Treasury ever spent, in cash and in treasuries and in deposits. In fact, Treasuries outstanding plus cash in circulation plus reserves are just the tangible record of the cumulative deficit spending, also by IDENTITY.

8. So when QE is going on, there is some combination of savers getting fewer coupons which constrains their aggregate demand just like a lower social security check would, and banks being forced out of duration instruments and into cash reserves. I do not think this makes them lend more their lending decision was not a function of their cashflow but rather a function of their capital and the opportunities out there (even when you judge a banks asset/equity capital ratio, there is no duration in accounting, so a reserve asset and a treasury asset both cost the same). If they had the capital and the opportunities, they would keep lending and force the Fed to give them the cash (via coupon passes and repos, which we then wouldnt call QE but rather preventing overnight rates from going to infinity). As far as I can tell, excess reserves is a meaningless operational overhang that has no impact on the economy or prices. The Fed is actually powering rates (cost of money) not supply (amount of money) which is coming from everyone else in the economy (Tres spending and private loan demand).

9. Ill grant there is a psychological component to inflation phenomenon, as well as a preponderance of ignorance about what reserves are, and that might result in some type of inflationary event in another universe, but not in the one we are in where interest rates are low and taxes are going up and the demand for savings is therefore rising rather than falling.

10. One can now retell history through this better lens. Big surpluses in 97-01, then a big tax cut in 03. Big surpluses in 27-30, then a huge deficit in 40-41. Was an aging Japanese public shocked into its savings rate or is that savings just the record of the recessionary deficit spending that came after 97? It will be interesting to watch what happens there as the demographic story forces households to live moreso off JGB income will this force the BOJ to push rates higher or will they never get it and force the deflation deeper?

11. There are, as always mitigating factors. Unlike in the Japan example, a huge chunk of US fixed income is held abroad, so lower rates are depriving less exported coupon income which is actually a benefit. There is of course some benefit from lower private sector borrowing rates as well MEW, lower startup costs for new capital investment, etc. Also, even if one denies that higher debt/gdp ratios are what weakened it (rather than Chinas decisions again something unavailable to Japan), the dollar IS weaker now which is inflationary. But this is all more than offset, I think, by ppls expectation that higher taxes are coming, and thats hugely deflationary and curbs aggregate demand via multiple channels.

12. Additionally, there seems to be a finite amount of political capital that can be spent via the deficit, and that amount seems to be rapidly running out. See https://portal.gs.com/gs/portal/home/fdh/?st=1&d=8055164. The period of deficit stimulus is mostly behind us. Instead, people are depending upon ZIRP and the Fed to stimulate the economy, and in fact there is marginal, and possible negative, stimulation coming from that channel. The Fed is taking away the social security checks knowns as coupon interest.

13. Finally, there is a huge caveat that I cant get around, which is whether we are measuring inflation correctly. It happens that I don’t think we are strange effects like declining inventory will provide upward pressure and lagged-accounting for rents providing downward pressure in the CPI. This is an unfortunate, untradeable fact about the universe that I think will be offset by other indicators (Core PCE) sending a better signal. But this is part of the reason this whole story will take time to develop in the marketplace. As a massive importer of goods and exporter of debts we are not quite Japan, but the path of misunderstanding is remarkably similar.

* Credit due Warren Mosler and moslereconomics.com for guiding my logic.

J. J. Lando


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Japan

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Karim writes:

There is a piece typifying the logic behind the buying of high strike payers in Japan (Japanese govt debt ‘Ponzi Scheme’).

Also heard GS put a similar piece out today but have not seen.

Makes no sense but seems to be gathering steam.

Right, the sustainability issue with floating FX is the issue of the sustainability of low inflation.

The ‘risk’ is that ‘excessive’ deficit spending adds inflationary demand, weakens the currency, etc. however the article seems to reject that argument as it suggests quantitative easing will continue due to weakness of demand, etc.

Nor are the ‘sustainability remedies’ applicable to floating FX. Any ‘stress’ is taken out by the exchange rate, and the way things generally work ‘excessive’ deficits increase nominal gdp/inflation and tend to stabilize debt/gdp ratios when that point of ‘excessiveness’ is reached.

As always, it’s about inflation, not solvency.
Govt spending is in no case inherently revenue constrained.
Any such constraints are necessarily self imposed.

This is all not to say this type of rhetoric can not trigger portfolio shifts and trading plays that can substantially move markets while they last.

In fact, that’s often what bubbles are.

Decline in Government Debt Sustainability
An extended period of heavy fiscal deficits will reduce the sustainability of government debt, which is already in the danger zone. The general-government debt was equivalent to 196% of GDP at the end of FY2008 (156% for long-term debt) and we project a rise to 222% (181%) for end-FY2010. This escalation is in part the consequence of low nominal GDP growth — we forecast an average -1.4% for 2009-10—and the average JGB yield is almost continuously above the nominal growth rate. The sustainability remedies are a deep cut in the debt ratio through sales and liquidation of government assets, combined with a demographic boost for the potential growth rate from measures to boost the birthrate and encourage immigration.


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Japan

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Nothing hopeful here:

The DPJ won power for the first time yesterday on a pledge to support households battered by two decades of economic stagnation. Hatoyama has also committed to avoid increasing government bond issuance, leaving his main initiative as a redistribution of the former Liberal Democratic Party government’s stimulus efforts, which focused on public works.


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JN Daily | Jobless Rate Moves Higher, CPI drops, HHold Spending Misses Expectations

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Looks like China is starting to stabilize Japan, which means it is probably helping the eurozone some as well.

  • Shipments Up Across Industries In June As Production Recovers
  • Cost Cuts Help Electronics Firms Reduce Losses In April-June
  • Jobless Rate Hits 6-Year High Of 5.4% In June
  • Household Spending Rises 0.2% In June
  • June CPI Falls At Record Pace
  • Housing Starts Fall 32.4% In June
  • June Const Orders Fall 8th Straight Month
  • LDP Aims For Steady Growth, Hints At Sales Tax Hike In Platform
  • Forex: Dollar Trades In Y95 Range Ahead Of U.S. GDP Data
  • Stocks: End Up, Set New ’09 High As Earnings Shine
  • Bonds: End Lower On Nikkei Rise, Pre-Tender Hedge


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