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Japan Expands its Monetary Base

8 April 2013 | Philip Ammerman

ZeroHedge recently re-published a series of reports by Dylan Grice of Societe General Cross Asset Research which are well worth a read.

This republication comes on the heels of the Central Bank of Japan's (BOJ) decision last week to increase the monetary base by $ 1.43 trillion to 2014. The $ 1.4 trillion would be used primarily to purchase Japanese government bonds (JGB), i.e. fund the country's tremendous debt stock and annual deficit.

This decision was portrayed as fulfilling four official and unstated policy goals:

a. Increasing annual inflation to 2%

b. Increasing the average length of JGB maturities from 3 years to 7 years

c. Funding the Japanese government (in the absence of other funding sources)

d. Driving down the value of the Japanese yen against other currencies, enabling exports

The Financial Times reported on the immediate effects of the announcement: 

The Nikkei 225 stock average closed up 2.2 per cent, snatching back losses earlier in the day. The benchmark 10-year bond yield fell almost a fifth to 0.446 per cent, matching the all-time low of June 2003. The yen tumbled from 92.91 to the US dollar to a two-week low of about 95.20.

We have heard any number of analysts saying that "Japan is different", mainly because its public debt is purchased almost exclusively by Japanese households and funds, and there is little net debt in foreign hands.

While this appears comforting, common sense, and Grice's analysis, lead one to question its validity in the "new normal" era of 300%+ public debt:GDP that will occur by 2014:

  • Grice's analysis shows that demographic change in Japan and falling disposable income levels have already led (in 2010), the Government Pension Investment Fund has already started selling JGBs due to a lack of funding.

Japan monetary base.png

Grice shows that Japanese government tax revenues no longer cover even discretionary income: all remaining non-discretionary income (socials security, education, debt interest) must be funded by debt issue.

Japan monetary base 2.png

By 2040, the working age population will have fallen from 87 million in 1995 to just over 40 million, while the dependency ratio of working employees to non-working population will have fallen to 1.1

Japan monetary base 3.png

In 2010, interest expenses already comprised 27% of government tax revenue, while debt service (including principal repayments) comprised nearly 60% of tax revenue.

Japan monetary base 3.png

The BOJ's decision to "expand the monetary base" by $ 1.4 trillion in two years needs to be assessed with these (and other) indicators in mind.

In the relative absence of other public institutions or private investors (companies, financial institutions, households) to purchase JGBs, the Central Bank has stepped in to take up the burden. This is very similar to what the US Federal Reserve or the European Central Bank (indirectly) have been doing.

But the BOJ's decision differs substantially both in terms of the scale of the operation, as well as due to the declining fiscal and demographic situation faced by the government.

The conclusions one can draw from this operation are the following:

  • The BOJ has become the lender of last resort for the Japanese government. Given that the $ 1.4 trillion will extend maturities and lower yields, this has bought breathing room for the government.

  • Unfortunately, the fact that no other meaningful structural reforms or demographic changes are being considered means that very soon, i.e. within the next 2 years, Japan will once again find itself facing the basic insolvency of its operations.

  • It remains to be seen to what extent the BOJ easing will "cannibalise" bond purchases by other domestic consumers of Japanese debts. The FT reports 10-year JGB yields of 0.45%: this does not correspond well to a stated inflation target of 2%, which will result in a total destruction of savings, on which the prior economic model has been based.

As a result, it's safe to say that the fundamental problems in Japan just got worse, the temporary reprieve notwithstanding.

With continual central bank operations of this type, it is very clear that the world--including China--has entered a new era of public finance. We, at least, are very pessimistic that this new era will be sustainable.

Rather than addressing the root causes of national competitivess and public finance, governments the world over appear to be camouflaging them in hopes of riding out the next electoral cycle. This is hardly a recipe for success.

Philip Ammerman

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Dylan Grice - Japan

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