A Bunkered Kuroda Swings His Easing Wedge
The BOJ’s recently reduced purchases of JGB’s have convinced some observers that the normalization is underway. JGB buying inertia, as a consequence of yield curve targeting, appears as a premature normalization. This belies the fact that the BOJ has compensated for its reduced JGB purchases with record purchases of equity linked ETF’s. In aggregate terms therefore, nothing has changed in relation to its overall commitment to the current phase of QQE. All that has changed is the mix of Qualitative and Quantitative Easing.
In fact it could be argued that the BOJ is now qualitatively easing; and may qualitatively ease further long after it has ended quantitative easing. So paranoid is the situation in Japan right now, that the recent slowdown in record ETF purchasing by the BOJ is now being viewed as another taper signal. Observers now see taper signals any time the BOJ reduces its purchases of either JGB’s or ETF’s for technical rather than policy reasons.
The iron laws of Japan’s demographics however may ultimately force the BOJ back to JGB purchases as Japanese tax payers age and die off, whilst their country’s debts are compounding. To test this thesis a catalyst is required. Political and trade risks derailing Abenomics may just be such catalysts.
The last report suggested that the path towards consensus to expand monetary policy further would be an arduous one for the BOJ. Masayoshi Amamiya aka Mr BOJ was noted as a key individual in building this consensus, based on his past exploits to build other ones for other BOJ policy objectives. Having been confirmed as a deputy, Mr BOJ then set his baseline from which to progress. He told reporters that, Japan is no longer in deflation but, consumer prices still have not reached the Bank of Japan’s 2 percent inflation target. He also said that he wanted to measure both the benefits and side-effects of the BOJ’s quantitative easing before addressing any policy steps.
Incoming BOJ deputy Masazumi Wakatabe wasted little time after his confirmation, before starting the arduous process of consensus building for more monetary policy expansion. Without calling for further expansion at this point, he used the catalyst of the latest disappointing CPI number to observe that inflation is still a long way from target and could be a lot better. Having established this baseline, he is in a position to proceed to build consensus from his colleagues.
On a second speaking engagement in front of parliament however, Wakatabe was less inclined to promote his thesis for further easing. In fact, he was more inclined to talk about the costs of easing for too long, especially on the banking system. He also noted that inflation is making steady progress. Wakatabe therefore appears to be in no hurry to achieve the consensus to ease further.
Wakatabe’s Dovish newly promoted BOJ colleagues Mr BOJ and Eiji Maeda have a slightly different mission at this part of the easing consensus building strategy. They have both noted how the market discounting mechanism has recently framed BOJ policy as normalizing. Their mission is to reframe consensus to first infer that there is no normalizing agenda, before going onto to expand this line of thought into suggesting that more easing is required.
Mr BOJ directly repudiated the notion, that the BOJ is tapering its bond purchases, by remarking that purchase levels and amounts dynamically fluctuate within the overall technical limits of yield curve targeting. BOJ Executive Director Eiji Maeda appears to be susceptible to any nudges towards further easing. Recently, he opined that inflation has been somewhat weaker and is still a distance from price target; so that the BoJ isn’t at a point where it can consider the exit from QQE. Mr Maeda has also stated that : “We’re (the BOJ) not in a stage where we need to consider the timing or means to change our current policy framework, including negative interest rates.”
In the face of these initial attempts to build the consensus for further easing, BOJ Governor Kuroda has raised the bar of adoption. The last report discussed the attempt at the “nuclear option”, of buying foreign bonds to weaken the Yen, suggested by Abe’s adviser Koichi Hamada . This initiative had even got as far as the parliament, where it has been tabled as a question for Kuroda. Kuroda responded to this question, in the broader context of the need for a new monetary stimulus, by stating unequivocally that policy will remain unchanged. He then framed perceptions of the current position of the BOJ, with his admission that discussions about how to normalize are ongoing; whilst it remains too early to guide the market officially about the outcome of these discussions.
The beginning of Kuroda’s second term as BOJ Governor has created the perfect prism through which to view relations between the BOJ and the Government.
Kuroda’s first press conference, provided clear evidence of cognitive dissonance between the BOJ and the Government. According to Kuroda’s recollection, his meeting with Prime Minister Abe on the first day of his new term was a mere formality. Allegedly, Prime Minister Abe told him that he would have the job for five years; and that they will both work together to set policy as required by the incoming data. There was no hint that they view this data differently.
Kuroda also recounted that, whilst it is premature to confuse the market with QQE exit talk at present, this is the next policy step for the BOJ and the tools are in place to do this when the time is right. He made it abundantly clear that the prime minister did not ask him to ease further; and that the headwind from the new sales tax hike will be smaller than the last. He also noted that he expects a fiscal stimulus from the government in the near future, that will presumably mitigate the sales tax hike and therefore take away the need to ease further. Kuroda thus set out his agenda for normalization; and implied that there was consensus with Abe about this.
Prime Minister Abe’s recollection, as reported by Kyodo News Agency, was somewhat different than Kuroda’s. Abe allegedly ordered Kuroda to press on further with the monetary stimulus.
The truth will out; and then we shall see who was telling the truth. Once safely out of Abe’s presence, Governor Kuroda stated that inflation has accelerated recently. The game of cat and mouse will continue it seems, until the data and/or Prime Minister Abe pins down the elusive Kuroda.
The latest Tankan survey suggests that the impact of the BOJ’s inertia, through the agency of a stronger Yen, is now feeding through into manufacturing sentiment. The Tankan index declined for the first time in two years. In addition, non-manufacturing sentiment declined also. More depressing reading came from the BOJ’s latest inflation survey. Inflation expectations took a hit in Q1, whilst long term expectations see the level only reaching 1.1% in three years’ time and then remaining at this level out to five years. There can be no doubt that Japan’s economic progress stalled in Q1. This should provide the foundation upon which to build the next easing consensus.
The latest output gap and growth potential data highlight the absurdity of the Japanese economy and the BOJ’s monetary policy behavior in relation it. Academically speaking Japan has a widening output gap, which should cause the BOJ no inflation worries and hence no need to tighten monetary policy. As currently advertised by Governor Kuroda all that is required now is time for the potential growth rate to move higher on and close the output gap. Life in Japan is just not like this though, for one very good reason. The potential growth rate is stalled around pre-Credit Crunch levels, suggesting that any further monetary and fiscal policy stimulus would just be inflationary and/or would create dangerous asset bubbles. Further monetary or fiscal stimulus, to nudge the potential growth rate higher, therefore come with large inherent risks.
Prudent BOJ Governor Kuroda has elected to stand pat and let the output gap narrow with inflationary consequences all of its own. He makes the big assumption that economic growth can sustain this narrowing of the output gap. But what if growth potential cannot rise to meet the rising growth curve? Furthermore, what if the flat potential growth curve has peaked at a new lower plateau, as the long term historic trend shows? The flat-lining potential growth curve may in actual fact be sending the signal that current economic growth should soon begin to converge back down towards it. Time will tell, but we are just about to find the answer to these questions very soon. All this has great implications for Japan’s mountain of debt that the BOJ is doing its best to buy up.
Looking at Japan’s debt time bomb, the economy has no potential to pay off its debts. Furthermore, the Japanese taxpayers are dying faster than their notional debts can be paid off. The BOJ thus has no choice, other than to monetize the country’s debts and hope that this will translate into a slide in the Yen which raises the growth potential (and the fertility rate!!!). It should be noted that without hyperinflation, which the BOJ evidently does not want, there is practically no way for the country to grow or inflate itself out of its debts. The BOJ therefore has to be the source of the monetary hyperinflation and the victim of it. As long as the monetary hyperinflation impacts the value of Japanese debt and not the real economy, then all will be well and good. Locating all of this debt on the BOJ’s balance is an effective way of achieving this monetary quarantine. It will take the acme of skill and patience for the BOJ to engineer its own fate gradually over time to avoid the volatility and risk associated with sudden death at the hands of hyperinflation.
The country will thus face technical default to the central bank, when the notional value of the debt is larger than the ability of the remaining living Japanese and their descendants’ ability to repay. At this point the BOJ can then ask the Ministry of Finance to print the currency required for the country to repay its debts. No real printing will be required, since all this can be done by computer book entry. Actuarially speaking, Japan may already be close to this point. The country however has to retain the pretence of appearing to be some way from this insolvency point. This may be why the BOJ never goes nuclear with its unconventional monetary policy and inter-spaces it with periods of alleged responsibility aka Yield Curve Targeting and guidance to match.
Currently, the BOJ is done with its recent attempts to weaken the Yen. Clearly the last attempt to weaken the Yen with unconventional monetary policy, although deemed radical by the BOJ and many commentators at the time, was actually very modest. Next time around, the BOJ will have to be bolder and more aggressive in pushing the envelope to the tipping point (but not beyond) at which a genuine hyperinflation phase threatens, in order to weaken the Yen to levels at which the potential growth curve could take a quantum leap higher. Demographics however suggest that this tipping point is theoretical in practice.
With an aging population, it will be impossible to achieve a shift in the potential growth curve in practice. Any hyperinflation will also meet the demographic headwind of an aging population that is maxed out on its consumption behavior. Japan watchers face an unedifying spectacle of watching the BOJ try and subsequently fail to the move the needle of the potential growth curve potential, with subsequently bolder moves in unconventional monetary policy. Buy the rumor, sell the fact has found its spiritual home in Japan. Governor Kuroda is however done with the latest round of trying to move the needle.
There is one solution, which would involve mass immigration in order to pass the country’s debts on to people who might live long enough to repay it. In the mid Twentieth Century Japan’s imperial ambition embraced a form of economic imperialism known as offshoring. This involved making the things, that old Japanese and robots cannot make in Japan, in foreign countries. The returns on investment accrued to the companies and the shareholders of the firms that offshored. The strengthening of the Yen has however significantly eroded these returns and the attraction of the strategy. The strategy has had no meaningful impact on the declining fertility rate either.
There is one solution that has not yet been tried, which involves immigration. This option does not seem politically acceptable to aging Japanese today, so that its legacy means that the best that future immigrants could hope for is residency without a vote. Perhaps Japan will opt for this kind of indentured labor solution, although the eventual rebellion of the helots over their aged masters is a certainty that may rule it out. In the absence of immigration, all bets are off and it is back to the BOJ’s continued purchase of every financial asset in the economy.
As it has now become clear that the BOJ will not expand monetary policy, without a lengthy consensus building process, the government is planning its contingencies by way of fiscal stimulus. Despite or perhaps inspired by the weak standing of Prime Minister Abe in the polls, the cabinet office is preparing the way for fiscal spending; ostensibly to counteract the headwind of the incoming rise in consumption tax which will be effective in October 2019. Current preparations are at the stage of recommendations by the cabinet office, that will then most likely get legislated into action.
As Japan goes into a period of economic policy stasis, until the case for further monetary policy easing becomes a consensus that can be accepted globally, the incoming economic data all point to a turning point (lower). Recent PMI data shows deceleration. The most worrying signal comes from the consumer. Household spending shrank 0.9 percent in February from a year earlier, the biggest drop since a 1.4 percent fall in April last year, while inflation-adjusted real wages fell for a third straight month in February, undercutting consumer buying power. The consumer is retrenching, even before he/she is hit with consumption tax increases.
The latest BOJ regional survey suggests that what the BOJ calls a “moderate” expansion is starting to plateau.
The global economic backdrop, which has been pulling Japan along, was also turning lower in early 2018; even before President Trump gave it a good kicking with his trade war rhetoric. Japan therefore has no domestic or global economic drivers to fall back on.
The BOJ has been supporting the banks by targeting the parts of the yield curve which enable the banks to widen their lending margins. In the meantime, the BOJ has been nudging the banks towards operational efficiencies and consolidation through mergers. It would appear that the banks have been taking the BOJ’s money but not its advice, which has caused the central bank to give them a more indelicate warning. The BOJ warned its errant lenders to curtail their growing habit, of lending at BOJ enabled margins to businesses which do not have strong balance sheets or internal positive cash flows, in view of the negative credit impact to this sector if and when the liquidity taps are turned off by the central bank.
(Source: Seeking Alpha)
The last report introduced the growing political scandal, which is undermining Abenomics and therefore ultimately may force the BOJ’s hand. Currently, the scandal is reducing the pressure on the BOJ to ease. The scandal is however having the impact of strengthening the Yen, as it is believed that the Governor Kuroda has defeated Prime Minister Abe’s pressure to ease further. The Yen strength will however ultimately force the BOJ to consider easing again.
Governing Kuroda may have signaled that internal debate at the BOJ is turning towards normalization, but reality suggests that debate over consensus to ease monetary policy further may intercede. The BOJ’s switch to Qualitative Easing of late, may turn out to be a signal of an escalation of this monetary policy easing with hindsight. Some clarity was provided, on how to frame this confused picture, by the traditional method of leaks from the BOJ. Said leaks leaked that the BOJ will forecast inflation hitting target in 2019 and then staying there in 2020. The next ease is therefore not even close, unless events and data intervene. By the same token however, tightening is totally out of the question also. The real issue is how to present the normalization when inflation hits target in 2019. The leakers may not have fully understood Governor Abe’s intentions and capabilities however.
As Prime Minister Abe enjoyed what may be his last round of golf with President Trump, as the two failed to reach a bilateral trade agreement in principle on the “back nine”, Governor Kuroda pulled out his sand wedge and waved it for all to see. Speaking at a G20 forum, he opined that “Protectionism isn’t having a huge impact on Japan’s economy yet. But the risk is right in front of us, so we need to carefully watch how developments unfold.” He then proceeded to frame said developments negatively in a follow up interview, in which he saw that “risks are skewed to the downside” for the chances of inflation hitting target in 2019. In an attempt to prevent the Yen from strengthening he even stated that he does not understand why it is viewed as a safe haven! As Japan heads into its next bunker therefore, in which it may lose Abenomics and face trade sanctions from America, Governor Kuroda is preparing to respond with more monetary policy easing.
The latest BOJ monetary policy meeting maintained the current status quo. Growth was forecast higher, whilst inflation was forecast slightly lower, for this year. Whilst there is uncertainty surrounding the behavior of consumers, in relation to the upcoming tax rate hike, the BOJ does not believe that the headwind will be as significant as the last one. Governor Kuroda is prepared to sit tight, whilst Prime Minister Abe takes the pressure for once. Ultimately however, the pressure will return to the BOJ as its dismal forecasts become an unbearable reality. Board members in general expressed a view that the risks are skewed to the downside on their growth and inflation forecasts, so the window to create consensus to ease further is opening. For now, only the isolated dissenting board member Goushi Kataoka is pushing the window to open further.
The big surprise from the last meeting came from Governor Kuroda. He informed that the time frame for achieving its 2% inflation target has been removed. On face value, one could argue that this move takes the pressure off the BOJ to ease monetary policy further. Governor Kuroda is however somewhat enigmatic; so it pays not to take him at face value. In an enigmatic context, he is admitting that the current monetary policy position has failed in its primary objective of hitting its inflation target. It is unlikely that he will sit still for the next five years and perpetuate the failure. Either he must go or he must stay and try and achieve his target. If he stays, then monetary policy must be expanded further.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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