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Over the years we have
read many times that the Bank of Japan (BOJ) has rapidly inflated the supply
of Yen. The 'pundits' who made such statements were obviously swayed by the
numerous announcements of QE programs emanating from Japanese officialdom,
but they should have done a little research rather than blindly assume that
these QE programs led to large increases in the economy-wide Yen supply. If
they had done the appropriate research they would have discovered that over
the past 20 years the annual rate of growth in the Yen supply (Japan's
monetary inflation rate) has oscillated in a narrow range around an average
of only 2%, and that it is presently near this long-term average. This is
illustrated by the following chart. The fact is that of the major currencies,
the Yen has had by far the slowest rate of supply growth over the past two
decades. That's why the Yen has maintained its purchasing power and why it
has been a relatively strong currency on a long-term basis despite the many
blatant short-term negatives.
On a side note, the following chart shows that Japan's money supply grew at
an average rate of around 10%/year during the boom years of the 1980s and
that the money-supply growth rate collapsed during 1990-1991. The monetary
transition from the bubble world to the post-bubble world is where
comparisons between the US and Japan break down. Whereas Japan's monetary
inflation rate tanked after its credit bubble burst, the US's monetary
inflation rate moved sharply higher. This is an important part of the
explanation for why things never got that bad in Japan and why the much-maligned
Japanese economy had stronger real growth over the past 10 years than the US
economy. The reality is that monetary inflation damages the economy. The more
'success' that the Fed enjoys in its efforts to maintain a high rate of US$
inflation, the worse things will inevitably get for the US economy.
On another side note, it's too bad that Japan's government went on one
Keynesian spending binge after another following the bursting of the credit
bubble. If it hadn't gone down this path, wasting resources on a grand scale
and racking up an enormous debt in the process, Japan's economy would probably
now be in very good shape.
As far as currency exchange
rates are concerned, the relative monetary inflation rate is the tide.
Interest rate differentials, trade balances, equity and commodity price
trends, government debt/deficit levels and differences in economic growth
rates are waves. The waves can dominate for periods of up to a few years, but
the tide will eventually have its way.
As mentioned in our opening paragraph, the tide has been in the Yen's favour for a long time. One result is illustrated by the
following weekly chart. Despite the US dollar's interest rate advantage over
the Yen during the entire 15-year period covered by the chart, the Yen has
been in a long-term bull market relative to the US$.
The US$ has done poorly
relative to most major currencies over the past 10-15 years, so let's check
the Yen's performance against a strong currency: the Australian Dollar (A$).
The following weekly chart shows that there have been some big multi-year
swings in the Yen/A$ exchange rate over the past 15 years, but the current
level of this rate is the same as it was in 2003 and the same as it was in
1998. During the period covered by this chart the A$ apparently had
everything going for it. In particular, the A$ had a large interest rate
advantage throughout, the Australian economy was consistently stronger than
the Japanese economy, there was a secular bull market in commodities that
attracted considerable foreign investment into Australia, and the Australian government
ran budget surpluses or small deficits whereas the Japanese government
relentlessly ran huge deficits. All of these 'waves' added together
constituted a powerful force, but they were counteracted by the tide
(Australia's average money-supply growth rate was much higher than Japan's
over the period in question).
The past has been characterised by relatively slow growth in the Yen supply
and long-term strength in the Yen, but the future could look very different.
Japan's government has racked up so much debt that at some point within the
next few years it will have to either directly default on a substantial
portion of its debt or enlist the help of the central bank (the BOJ). Either
way, savers will be hurt. A lot of Japanese savers are invested in government
bonds, so a direct default would result in large nominal losses for many
members of the voting public. It would be blatantly obvious that the
government was to blame for the losses, so the government that took this
action would effectively be committing political hara-kiri. That's why it is
more likely that the government will enlist the help of the BOJ.
The BOJ could monetise a large slice of the debt.
While this wouldn't reduce the total size of the debt burden, it would effect a transfer from the balance sheets of voting investors
to the balance sheet of the central bank. The debt could then be defaulted
on, with the BOJ taking the loss. Due to the Yen's loss of purchasing power,
the cost to savers would be just as great as it would be in the case of a
direct default. Moreover, the cost to the overall economy would be greater if
the monetisation route were taken due to the
distortion of price signals and the mal-investment caused by creating a lot
of money out of nothing. However, it would have the political advantage of making
it more difficult for the average person to correctly assign blame.
Large-scale debt monetisation will very likely
occur in Japan, leading to the Yen becoming a relatively weak currency. The
difficult question is: when will the large-scale monetisation
begin? We don't know the answer. A year ago we thought it would have begun by
now, but clearly it hasn't.
Steve Saville
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