January 9, 2017

Chart of the Week: BoJ – trusting to luck

by Fathom Consulting

In November, the BoJ got a lucky break as markets anticipated a more rapid tightening from the US Fed, and the yen fell back. But relying on lucky breaks is not a sustainable strategy – Abenomics must change radically or be abandoned. Japan’s economy is weighed down by debt and its policymakers must reduce that burden or accept another lost decade.

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Despite appreciating sharply in the first three quarters of 2016, the Japanese yen ended the year just 3% higher against the US dollar. Expectations of policy divergence, as well as a more ‘risk-on’ environment, appear to be the driving force behind the coveted depreciation that took place in November and extended into mid-December.

To date, Mr Trump’s election victory has not been the disaster that many had feared. His promise to enact a ‘fiscal splurge’ has fostered expectations of higher US inflation and a faster pace of US interest rate tightening. Together with the Bank of Japan’s commitment to keep yields on ten year Japanese Government Bonds (JGBs) at zero, this has seen the spread between US treasuries and the Japanese benchmark widen considerably.

But there remains a significant risk that Mr Trump’s protectionist campaign rhetoric will become reality, upsetting the apple cart and sending the safe-haven yen soaring once again. The Bank of Japan cannot rely on the policy whims of its rate-setting counterparts to slay its deflationary behemoth and end decades of economic malaise. Depending on lucky breaks is not a sustainable strategy.

We stand by our view that helicopter money, meaning a money-financed fiscal expansion, will prove to be Japan’s only real option. When the nation’s problems began in the late 1980s, its government debt stood at a little under 70% of GDP. After more than two decades of failed public works, that ratio has reached just over 230%. With tepid growth, and muted inflation, this money will never be repaid.

The solution cannot be more debt — whether government, corporate or household. And in a desperate bid to stimulate demand, the Bank of Japan’s interest rate strategy has done more harm than good — progressively undermining the supply side of the economy by preventing the gales of creative destruction. Japan, and other economies following in its footsteps, need to move from a high-debt/low yield equilibrium to a normal debt/normal yield equilibrium.


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