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Abenomics at work

May 11, 2013

As I have written several times this year about Japan’s radical economic plan referred to as “Abenomics” https://rpreschern.wordpress.com/2013/01/05/dancing-on-mount-fuji-japan-in-2013/ , Japan has found its way into the headlines once again. On Thursday, the Yen breached the 100Yen/$ mark and has lost over 20% since the new prime minister took office half a year ago. For those of you that don’t remember what Abenomics stands for, here a quick explanation on my part followed by two fitting cartoons.

abe

Prime Minister Abe appointed a central bank governor who has agreed to double the supply of yen within two years. Crushing the exchange rate should give Japanese exporters an advantage over their foreign competitors and thus, reignite economic growth. Of course, the chain reaction this causes on the global stage as well as the fact that anyone holding yen and Japanese bonds is losing their purchasing power is of seemingly less importance today.

Two further graphic explanations can be found below…

Abenomics

Abenomics and drug addiction

It is certainly true that lowering the value of one’s currency makes domestic products more attractive to foreign markets but it is really a subsidy paid for by currency/bond holders of Japan. After all, Japan imports practically all of its natural resources and those have gone up 20% in price in recent months as well. Furthermore, foreign competitors feel cheated and pressure their governments to retaliate.

Currency Wars

Until globalization became a respected concept of modern-day economics via the WTO, there have always been protective measures against foreign competition. In the old days, trade wars were conducted via tariffs and import quotas/bans/embargos whereas today, we all claim to live in a  free global world yet we choose to let/urge central banks to conduct currency devaluations to gain global market share rather than the old subsidies. Of course, there is absolutely no difference in the end result: higher prices for all imported goods. Furthermore, the policy of doubling the money supply in two years has caused all other central banks to follow suit by either lowering interest rates, printing money or intervening in the currency markets to lower domestic currencies. Five central banks alone lowered interest rates in the last week, New Zealand intervened in the market to lower its currency and the ECB is considering negative interest rates to lower the Euro.

Undoubtedly, destroying the purchasing power of practically all currencies is not a panacea to structural economic problems. However, as the hungry dog in the cartoon, it is very pleasant in the short run as all this liquidity finds itself pouring into the financial markets which then boom. The Federal Reserve and the Bank of  Japan now create a combined $155 billion a month out of thin air. Since interest rates have practically been abolished, any risk asset with a yield is now invested in no matter what the criteria. After all, when your borrowing costs are zero, anything looks better than zero yielding cash that loses purchasing power.

Race to debase

kamikaze_ben

This “race to debase” works in the short run in nominal terms but in my opinion this policy will lead to an inevitable counter reaction whereby all financial assets drop at once. While we hear about exit strategies once the economy improves it is clear to me that there can be no graceful exit. Look at the Federal Reserve in America for example. It now sits on over $3 trillion of highly interest sensitive Treasuries and mortgage securities. If it were to exit its stimulus it would have to sell that portfolio. Can anyone tell me who would be willing(and able) to buy $3 trillion of Treasuries and mortgage securities at current interest rates from the Federal Reserve? This is impossible to do without crashing the bond markets and consequently, stock and currency markets.

On the other hand,  if the Fed were to raise interest rates it would destroy its own balance sheet and bankrupt the federal government through higher interest payments. Remember, for every percentage in interest, the federal government currently would have to pay an additional $170 billion a year to service its debt, on top of the trillion-dollar deficit it currently produces and finances via Fed money printing.

Federal Reserve Balance Sheet

A good friend of mine and expert pointed out that the Fed could  just let the balance sheet mature and not renew its purchases. In theory, this is a nice idea but in reality, who would then step in and purchase the debt that the government needs to roll over at maturity? In other words, what private capital entities would be willing and able to lend $3 trillion to the US government and mortgage holders at current interest rates? It won’t happen and that’s why all major central banks have their backs to the wall at this point. Unless there is structural reform and growth, this party will end badly. Printing more money postpones the day of reckoning and should work until a currency goes into free fall.  Let’s watch Japan and see what happens. After all, they are “winning” the race at the moment and are most likely to reach the finish line first.

The yellow brick road

How do you protect yourself from the possibility of an eventual demise of our current monetary system? Real assets. Anything that can’t be printed and has lasting value should weather the storm. High quality equities come to mind. As long as the company you own shares in stays in business you should be ok. Farm land can’t be printed and it even yields food every year. As for currencies, gold and to a lesser extent, silver, platinum and palladium serve the same purpose as stores of value.

Coincidentally the currency wars are being conducted in gold as well(see below)

currency war

Ask yourself which party you would rather be in the end. The one with all the gold or the one with all the paper money?

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2 Comments
  1. Tim permalink

    Another great explantion of our current fiscal woes, this time on how monetary stimulus has supplanted tariffs. When the musics stops there will be many people left standing, and not many chairs…Richard, I don’t know if you are planning (or interested) in writing a book, but you certainly have enough material. Great work.

  2. Tim,
    I agree with you fully and worry beyond the financial implications of the “music stopping”. A scenario in which all financial assets drop simultaneously while consumer prices increase is a dangerous situation that is becoming more probable with every day of QE. I don’t think most financial advisers consider this scenario to be possible and will find out the hard way when a sovereign debt crisis suddenly appears.
    As for writing a book, thank you for finding my ideas worthy. I haven’t really thought about it but perhaps, there is enough demand for such writing? It certainly would make it easier to organize all these articles/ideas I have written into a structured format. For now, I am content writing this blog but I am open to the idea…
    Thank you for your positive feed back, it keeps me going!

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