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The BOJ Ups The Ante


Yenergize: to energize the economy by creating Yen.

Three months ago, I wrote a blog with the title, “Japan’s Horrible GDP Data May Be Good For Stocks”. There, I suggested that Japan’s economy was so weak that the Bank of Japan (BOJ) would probably have to increase the size of its fiat money creation program (which it calls Quantitative and Qualitative Easing or QQE for short). I wrote:

“…if the BOJ does expand QQE still further, then the Yen will weaken, Japanese corporate profits will improve and the stock market will rise. This is a scenario where, at least for a short while, it would once again be relatively easy to make money in Japan. I believe this week’s horrible GDP report has made this scenario increasingly probable.”

Earlier in the year, there had been a number of hints from the BOJ that QQE might be increased, but since those had occurred some time back, market speculation about additional QQE had begun to die down. So the markets were flabbergasted on October 31st, when the BOJ did announce it intended to increase its Yen creation and asset purchases from Yen 60 – 70 trillion a year to Yen 80 trillion (approximately US$725 billion a year).

Coming only two days after the Fed ended the third round of Quantitative Easing in the United States, the BOJ’s announcement was timed to have maximum impact – and it did. The Japanese stock market jumped 5% that day and the Yen moved sharply lower. Two weeks later, the Nikkei Index is at a seven year high, while the Yen is at a seven year low.

So, what happened? Why was more QQE necessary? The simple answer is that more QQE was necessary because the initial round of QQE had run out of steam. Although the Bank of Japan would never admit it, QQE works by pushing down the value of the Yen. But, 19 months after the program was initially launched, the Yen had stopped falling, the stock market was flat, the economy was weakening and the inflation rate had started to move back down toward deflation. Therefore, the BOJ either had to up the ante or admit defeat. It decided to up the ante and energize (or perhaps we should say Yenergize) the economy by creating even more Yen.

Now what? Japan’s economy faces very severe challenges. Japanese wages are too high to allow goods made in Japan to be competitive against goods made in countries with much lower wage costs, such as China. After the Fukushima nuclear disaster, Japan’s energy import bill skyrocketed and threw the country’s trade balance into deficit. The population is not only ageing, it is actually shrinking. Japan has been struggling against deflation since the mid-1990s. And, Japanese government debt to GDP is nearly 250%. In April, the government increased the consumption tax to put its finances on a more sustainable footing, but that tax hike knocked the wind out of the economy and threatened to throw it back into recession. Therefore, the economy badly needed another jolt of stimulus to prevent a new slump.

Now, thanks to the expansion of QQE to Yen 80 trillion a year, the economy is likely to rebound. The lower Yen will improve the competitiveness of Japanese exports and corporate profits. That, in turn, will boost the stock market and create a wealth effect that will help drive domestic economic growth.

Unfortunately, printing more Yen is only a short-term fix, not a long-term solution, for Japan’s woes. It will only benefit the economy so long as the Yen continues to depreciate. Six months or a year from now the BOJ may have to up the ante again with another monetary jolt. Once a country begins printing money to stimulate the economy, it is very difficult to stop.

This saga is likely to end very badly, eventually (unless the BOJ ultimately cancels all of the government bonds it has acquired through QQE). Meanwhile, the near term outlook has improved - for the economy, for Japanese stock prices and for Prime Minister Abe, who has staked his career on defeating deflation and reviving the economy. According to press reports, the Japanese Prime Minister will announce snap Parliamentary elections next week and postpone the second stage of the consumption tax hike, which had been scheduled for next October. If these reports prove true, investors are very likely to welcome the news and push the Japanese stock market higher still.

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Original publish date: November 15, 2014

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