'We're on Track, We're on Track …' – Just Say it Often Enough

When Mr. Kuroda was appointed governor of the BoJ, there was great excitement in the markets. A committed inflationist! Practically a resurrected John Law, disguised as a bookish-looking Japanese functionary. Let's sell the yen, buy the Nikkei and get rid of our JGBs at once!

It seems though that the magic is gone now. After a string of rather disappointing economic data emanating from Japan lately (and keep in mind that the previous string of allegedly 'strong' data was largely the result of statistical tomfoolery), the Nikkei and the yen stalling out, and the JGB almost back at its previous record high, all that Japan has to show for the effort are somewhat poorer consumers, whose real income is now declining.

Apparently Kuroda is unperturbed though:

“The Bank of Japan maintained its expansionary monetary policy on Tuesday and extended special loan programs to help buoy economic growth, signaling its resolve to keep the positive mood generated by premier Shinzo Abe's reflationary policies from fading. The central bank reiterated its upbeat view on the economy, unfazed by recent signs of slowing growth and suggesting that any additional stimulus will be some time away.

[...]

BOJ Governor Haruhiko Kuroda said the expansion was aimed at enhancing the transmission mechanism of quantitative easing by encouraging banks to boost lending instead of sitting on piles of cash. "We have an engine with big horsepower, so it makes sense to have stronger tires," he told reporters after the decision.

While some investors viewed the loan program expansion as a policy signal the BOJ may take a more accommodative stance if necessary, Masashi Murata, senior currency strategist at Brown Brothers Harriman, cautioned that the reaction in the Japanese government bond market suggested this was not the case. "Bank shares drove the Nikkei, which drove the yen, but JGBs did not react much," he said.

As widely expected, the BOJ on Tuesday maintained its pledge of increasing base money, its key monetary policy gauge, at an annual pace of 60-70 trillion yen ($589-$687 billion). The central bank also stuck to its assessment that Japan is recovering moderately, a sign it remains confident the world's third-largest economy can weather the pain from a sales tax increase in April without additional stimulus. "The BOJ already expects the economy to contract immediately after the sales tax hike, so this cannot be the basis for additional easing," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management in Tokyo.

The BOJ has stood pat on policy since launching an intense burst of stimulus last April, when it pledged to accelerate inflation to 2 percent in roughly two years via aggressive asset purchases in a country mired in deflation for 15 years. Monday's weaker-than-expected fourth-quarter GDP has dashed hopes that a rush in household spending ahead of the April tax hike would cushion the pain from sluggish export growth. While the BOJ is in no mood to act immediately, market pressure for further stimulus may heighten in coming months if there is more evidence that personal consumption is losing momentum, some analysts say.

Kuroda, however, remained sanguine, saying he saw no threat to the bank's rosy projections with overseas demand seen picking up and rising income underpinning consumption. "If risks materialize, we will not hesitate adjusting policy, but for now Japan's economy is on track and moving in line with our forecasts," he said.

As expected, the BOJ extended three special loan facilities by one year from their scheduled expiry in March. Of the three, it doubled funds available to banks under two facilities — one that encourages banks to funnel money to industries with growth potential and another that offers cheap funds to banks that boost lending. Both give banks access to funds for four years at a fixed rate of 0.1 percent.

But analysts doubt how much the expansion will do to boost lending, which has increased only moderately despite the BOJ's aggressive stimulus on sluggish corporate demand for funds. Of the combined 21.5 trillion yen that had already been set aside under the three facilities, less than 9 trillion yen has been tapped so far. Kuroda acknowledged that the BOJ was counting somewhat on the psychological effect by boosting the lending facilities. "We attempt to strengthen the incentive for banks to tap these facilities," he said. "We've included a strong message of support for these programs.”

(emphasis added)

This time, Kuroda's action (i.e., the extension and doubling of one of the special lending facilities) had only a very short-lived impact. Obviously, expanding a facility that is not even fully used at its current size doesn't make much sense. The yen fell for just one day and then resumed its recent retracement rally:

Yen not impressed by Kuroda's attempt to boost a special lending facility that is underused anyway – click to enlarge.

A long term chart of the JGB continues to indicate that the market a) still does not believe 'reflation' will succeed and b) is not yet worried about Japan's recently growing current account deficit (the 2013 deficit was the biggest since 1985, although it remains quite small in absolute terms at just below $ 6 billion). A widespread assumption is that once the Abe government switches Japan's nuclear power stations back on, the c/a deficit will turn into a surplus once more, which is  probably a reasonable enough bet. 

However, Japan remains the scene of one of the world's biggest real life economic experiments: it is the place where the widely held assumption that unrelenting growth in government debt 'doesn't matter' (just as long as one has a printing press and needs no foreign financing) is being put to the test. In other words, the calm in the JGB market is likely to prove ephemeral, even though no-one can say for sure for how much longer. Shorting the JGB market is called the 'widow-maker trade' for a good reason. Of course it all will matter one of these days, and when it finally does, we will have a global 'interesting times' spectacle on our hands (as a great many closely related assumptions pertaining to other countries will have to be discarded in a hurry).

Japan's 10 year JGB future: the big reflation yawn – click to enlarge

Money Supply Growth Accelerates

In Japan one can employ M1 as a good proxy for money TMS, as it consists solely of currency and demand deposits. Below are two charts: one that shows Japanese M1 in absolute terms, and one that shows its annual growth rate. It turns out that the BoJ's efforts have finally had a discernible effect on the money supply, as its growth rate has briefly accelerated to the fastest rate in years in late 2013  (it still remains below that in the US and the euro area). At just below 6% it may by now actually have caught up or be close to catching up with euro area money supply growth, which has been decelerating sharply of late.

This is a bit surprising, as the BoJ's QE policies have hitherto had only very little effect on money supply growth. However, recall that something similar happened in the UK as well – 'QE' initially had no effect on money supply growth, but eventually the banks decided to accelerate their inflationary lending and the UK money supply growth rate quite quickly exploded to more than 10% annualized – the highest rate of change in the major currency areas.

Japan's money supply M 1 as of January (currency and demand deposits) - click to enlarge.

Japan's M1, annualized growth rate – briefly spiking above 6% in 2013, a level not seen in many years – click to enlarge.

Conclusion:

Perhaps Kuroda is so sanguine because of the recent acceleration in money supply growth. It certainly supports the idea that the inflationary policy is beginning to 'work'. Of course, the policy is an even worse blunder if it actually doessucceed, as that means we have to expect that all the effects of an inflation-driven business cycle will kick in, including the redistribution of wealth from poor to rich, and increasing malinvestment of scarce capital. Japanese consumers are already chafing from the effect the sharp decline in the yen has had on the prices of imports. According to the Kuroda-Abe playbook this is apparently deemed a 'success', but we bet that Japan's consumers think otherwise.

One really wonders what has to happen before inflationary policy is finally discredited for good. Its central bank-directed version has been failing consistently since at least the early 18^th century when John Law embarked on his infamous inflationary scheme in France. If one relaxes the central bank stipulation, one can look back even further to the Roman empire if one wants to find earlier examples. Given this record, we should probably not get our hopes up too much. Even if the whole world eventually crashed and burns, the policy will probably still not fall from grace. Instead we should expect that a well-worn staple of profligate governments will be revived: they will simply blame everyone else (hedge funds and speculators in general always make for good targets). See our earlier article on Venezuela for a pertinent recent illustration.