Conventional thinking and reporting has it that Japan is conducting a
larger version of the same monetary experiment they’ve been running for about
15 years. The implication here is that we can safely analyze what Japan
is up to through the same monetary lens, as always, but with a slightly wider
aperture.
By now, we are all familiar with the details. Japan has initiated a
program of monetary expansion that goes by the shorthand of 2-2-2. In two
years, the Bank of Japan (BoJ) will fully double the
monetary base as it seeks a minimum of 2% inflation.
In the aftermath of this announcement, the yen weakened by a whopping 8%
against the dollar, the Nikkei stock average vaulted up by roughly 10%, and
the $10 trillion Japanese government bond market had to be frozen twice
because of intense volatility.
In truth, what Japan is running is as much a massive social experiment as
it is a monetary experiment. It has such enormous implications to
everyone, but especially the Japanese people, that we should all be paying
very close attention.
Creating Inflation
The basic formula for creating inflation involves more money and credit
chasing too few goods. Whether this is more goods (just not enough to
match the growth in money and credit), the same amount of goods, or even
fewer goods is not important. What matters is that there is more money
and credit than goods.
On this front, so far, so good. Japan is going to fully double (!)
the monetary base in just two years. In any tidy, mathematical world
where economics is governed by linear, rational processes, this doubling of
the monetary base would result in inflation.
Unfortunately, the real world is not very tidy.
The monetary base is really an abstraction that refers to the amount of
money that the banking system has available to pyramid into a greater number
of loans. As I am sure you have figured out by now, simply having more
money in the system will not automatically result in more money chasing
goods.
In fact, without a good reason to borrow and then spend that money, those
new funds may well just sit in the banking system chasing nothing related to
real goods and services in the real economy. Instead, that money will
simply chase financial assets such as stocks and bonds.
The BoJ knows this, and yet their plan revolves around the idea that they
can create inflation by simply doubling the monetary base. Does this
mean they are confident that there is pent-up consumer demand that was
stymied by a lack of cheap funds from the banking system?
The very short answer is ‘no.’ The BoJ knows perfectly well
that more base money will do nothing to stimulate additional inflation via
consumer demand, and they know this because Japan has had rock-bottom
borrowing costs for a very long time.
The Real Target – Trust
So if the BoJ already knows that more base money will not lead to the
buying of more goods and services, then what is their plan for stoking
inflation?
The answer is both simple and somewhat upsetting: They are targeting
people’s trust in the yen. The idea is simple to understand, as
inflation requires that people prefer to hold ‘things’ instead of
money. That is, the preference for money is diminished and the preference
for real things, perhaps anything other than money, is elevated.
If enough people decide that holding money is a losing proposition, they
will favor consumption instead. The way to get people to favor things
instead of money is to debase their confidence in money. So people’s
trust in money has to be targeted, and this is, indeed, the BoJ’s target.
The sad part of this story is that the BoJ is seeking a 2% (minimum)
inflation target under the theory that higher inflation will be good for the
economy and therefore Japanese businesses and therefore Japan.
The problem is that there are multiple reasons that prices might
rise. Some of them are beneficial to these inflationary aims, and some
of them are destructive. For example, if prices rise because people
lose confidence in the yen, and prices rise because imports cost more, then
this simply hurts consumers at the benefit of exporters.
In short, there is no net societal gain. The accounting identity in
play here is that one entity’s loss is another entity’s gain. If
consumers and importers have to pay more for imported goods simply because
the yen has fallen in value, then all we have to work out is who gains.
Exporters gain, by and large, as do other sectors.
That’s just the way these things work – it is not possible to engineer a
gain where everybody benefits because one sector’s deficit automatically
becomes another sector’s gain. It is simply Newtonian physics.
For every force, there is an equal and opposing force – only the forces are
economic and involve gains and losses.
The form of inflation that Japan hopes to stoke involves the kind where
money currently stored in Japanese bank accounts comes roaring out into the
Japanese economy. The BoJ is willing to harness the import/export
losses as a useful means of convincing the local businesses and populace that
the yen is just not a safe store of value.
So the basic plan that the BoJ has put into motion is to ruin local faith
in the yen. It is actively targeting trust, a necessary component of
any fiat-based currency, under the twin theories that it knows what it is
doing and will know when to stop.
The problems are that I am pretty sure they will succeed beyond their
wildest hopes and that nobody at the BoJ has any experience in massive social
engineering experiments.
Conclusion
The BoJ is not just running the largest monetary experiment in their
history, but also the largest social engineering experiment.
Trust is an essential component in every economy and for every
currency. The BoJ has just upped the ante by explicitly and
specifically targeting trust in the yen. Perhaps they know what they are
doing, and we certainly hope so, but I happen to think it is playing with
fire.
There really aren’t any guidebooks for it to follow, and even if there
were, it is doubtful that the economists in charge would have been required
to study them during their academic training and political careers.
If the notion of your pilots flying blind bothers you, then you are
probably not very happy or confident with the BoJ’s actions here. Were
I a Japanese citizen, I would immediately convert my yen holdings to
something, anything, else. Swiss francs, gold, dollars – anything (!)
would be preferable to me here.
Once your central bank declares war on its own currency, this is just the
prudent thing to do.
For everyone else, Japan is now the largest economic Petri dish on the
planet and is well worth studying for what happens next. The early
results, with a manic pulse in the Nikkei coincident with arrhythmic
gyrations in the Japanese government bond market, suggest that something has
been shaken loose in Japan.
Trust, perhaps?
~ Chris Martenson
