Source: usdkenkyusyo.livedoor.biz This week has seen a myriad of opinion pieces flooding the financial media in relation to the decision on Tuesday by the Bank of Japan (BoJ) to engage in an open-ended bond buying program (called Open Ended Asset Purchasing) and increase the inflation target for the Japanese economy to 2%. In a statement released by the BoJ, it said that…”The bank recognises that Japan’s economy faces the critical challenge of overcoming deflation as early as possible and returning to the sustainable growth path with price stability.” The reaction of commentators to this announcement was mixed, to say the very least. While some recognised that PM Abe was at last pursuing a more aggressive monetary policy in an effort to halt deflation, weaken the yen against the dollar (by a ratio of Y100 to $1), boost exports and haul Japan out of two decades of economic stagnation, most saw the move as being one of considerable risk and liable to exacerbate the problems it was meant to solve.
Some of the more astute foreign observations noted that interest rates on 10-year government bonds in Japan yield less than 1%, a situation supported by nearly a decade of domestic price deflation and the strength of the yen against other currencies (this state of affairs went into overdrive in the wake of the GFC, when Japan became a haven for investors seeking shelter from more volatile currencies). As the yen rose in value, yields on Japanese bonds also rose, with the real interest rate higher than the nominal rate. However the decision by the Abe government to inject the economy with a continuous series of quantitative easing measures, which would assist Japan in meeting its 2% inflation target, will weaken the yen against other currencies and drive up domestic prices, thereby bringing about the inflation that Abe desires.
Placing aside questions of whether such currency manipulation will result in similar measures being taken by other governments (the US among them), the real risk in this strategy amounts to two things: rapid inflation, and a burgeoning public debt. The continuous monetisation of debt by the BoJ could lead to an exodus in investors, as increased inflation, coupled with a weaker yen, will threaten the interest rate on Japanese bonds. Furthermore, increased interest rates will result in a dramatic expansion in public debt. As is often pointed out, with an overall government debt to GDP ratio of 230% (higher than any other developed nation), a growth in the cost of borrowing by the government could mean that the annual budget deficit will expand from its current 10% of GDP to 20% over the course of 12 months. This in turn will create an unsustainable situation; rising interest rates, coupled with expanding debt.
Rising interest rates would place at risk those government bonds held by Japan’s banks (around 90% of JGBs are held in Japan’s banking institutions), which would gradually lose their value and rate of return, and that would impact upon household savings just as the household saving rate continues to decline (less than 2% as of late 2012). With a reduced pool of finances to drawn upon and an increasing debt ratio, the Abe government may have no other resource than to sell off its debt to foreign buyers, and that will place Japan in the hands of international regulators who will have no hesitation in imposing penalties should Japan default on its debts as a result of a rapidly escalating inflation rate.
Another, more pressing, reason for Abe’s injection of funds into the economy appears to be the desire to not only to reinforce support among traditional LDP rural constituencies and financiers (namely construction groups), but to ensure that the public is sufficiently impressed to vote for a majority of Coalition MPs standing for seats in the House of Councillors election this year. As LDP President Ishiba Shigeru put it, if the Coalition loses the House of Councillors, then the victory in the House of Representatives in December will have been for naught (J). While one might say that the cash injection was merely to improve the LDP’s electoral prospects, the public announcement of a 2% inflation target and continuous easing strategy hints at a long-term strategy imbedded within a short-term policy. Speaking hypothetically, a rise in exports could revive the employment market in Japan. Recognition of stimulus measures that generate jobs could then convince voters of Abe’s suitability to continue his reforms. An improved economy, coupled with regional tensions, may then see the LDP take control of the House of Councillors and give approval for constitutional revision. Abe, having fulfilled the task he first set out to achieve in 2007, could then be assured of his place in history. Far-fetched? Not necessarily, however should inflation rise beyond expectations, wiping out savings and bond returns before the economy has a chance to improve, then Abe will be remembered for very different reasons indeed.
Some of the more astute foreign observations noted that interest rates on 10-year government bonds in Japan yield less than 1%, a situation supported by nearly a decade of domestic price deflation and the strength of the yen against other currencies (this state of affairs went into overdrive in the wake of the GFC, when Japan became a haven for investors seeking shelter from more volatile currencies). As the yen rose in value, yields on Japanese bonds also rose, with the real interest rate higher than the nominal rate. However the decision by the Abe government to inject the economy with a continuous series of quantitative easing measures, which would assist Japan in meeting its 2% inflation target, will weaken the yen against other currencies and drive up domestic prices, thereby bringing about the inflation that Abe desires.
Placing aside questions of whether such currency manipulation will result in similar measures being taken by other governments (the US among them), the real risk in this strategy amounts to two things: rapid inflation, and a burgeoning public debt. The continuous monetisation of debt by the BoJ could lead to an exodus in investors, as increased inflation, coupled with a weaker yen, will threaten the interest rate on Japanese bonds. Furthermore, increased interest rates will result in a dramatic expansion in public debt. As is often pointed out, with an overall government debt to GDP ratio of 230% (higher than any other developed nation), a growth in the cost of borrowing by the government could mean that the annual budget deficit will expand from its current 10% of GDP to 20% over the course of 12 months. This in turn will create an unsustainable situation; rising interest rates, coupled with expanding debt.
Rising interest rates would place at risk those government bonds held by Japan’s banks (around 90% of JGBs are held in Japan’s banking institutions), which would gradually lose their value and rate of return, and that would impact upon household savings just as the household saving rate continues to decline (less than 2% as of late 2012). With a reduced pool of finances to drawn upon and an increasing debt ratio, the Abe government may have no other resource than to sell off its debt to foreign buyers, and that will place Japan in the hands of international regulators who will have no hesitation in imposing penalties should Japan default on its debts as a result of a rapidly escalating inflation rate.
Another, more pressing, reason for Abe’s injection of funds into the economy appears to be the desire to not only to reinforce support among traditional LDP rural constituencies and financiers (namely construction groups), but to ensure that the public is sufficiently impressed to vote for a majority of Coalition MPs standing for seats in the House of Councillors election this year. As LDP President Ishiba Shigeru put it, if the Coalition loses the House of Councillors, then the victory in the House of Representatives in December will have been for naught (J). While one might say that the cash injection was merely to improve the LDP’s electoral prospects, the public announcement of a 2% inflation target and continuous easing strategy hints at a long-term strategy imbedded within a short-term policy. Speaking hypothetically, a rise in exports could revive the employment market in Japan. Recognition of stimulus measures that generate jobs could then convince voters of Abe’s suitability to continue his reforms. An improved economy, coupled with regional tensions, may then see the LDP take control of the House of Councillors and give approval for constitutional revision. Abe, having fulfilled the task he first set out to achieve in 2007, could then be assured of his place in history. Far-fetched? Not necessarily, however should inflation rise beyond expectations, wiping out savings and bond returns before the economy has a chance to improve, then Abe will be remembered for very different reasons indeed.
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