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The
issue this week was the meeting of the Bank of Japan where they debated what
to do about a Yen strong enough to damage Japanese exports, the mainstay of
the Japanese economy. It was agreed that Japan
will spend 920 billion yen [$10.8 billion] on economic stimulus and compile
an extra budget if needed. The central bank expanded a loan
program by 10 trillion yen [$116 billion]. This left the market
underwhelmed and the Yen went stronger still. This was a red rag
to a bull as it invited speculators to push the Yen even higher.
They will keep pushing it up until the B of J takes sufficient action to
prevent its rise. The talk is now that it will rise to around Yen
78 against the U.S. Dollar, which will force crisis action on the government.
But far more than meets the eye lies in this action and potential
action.
1.
It
attacks the reasoning behind Exchange Rates
2.
It
encourages speculation both on the Yen and, unlike the U.S. does not fill the
holes caused by deflation but devalues the buying power of the Yen with an
inflationary stimulus.
Both these
actions undermine Japanese money internally and externally.
Exchange Rate
Determination Rules
If no one objects
to this, then a tacit approval of this policy is being given. If
this is the case, then you can be sure that other major nations will follow
suit. What of price stability and exchange rates that accurately
reflect the Balance of Payments of a nation. To understand the
importance of these issues we take you back to the last time you heard the
U.S. complain about the undervaluation of the Chinese Yuan. It is
perceived by many in government and in both parties that the Chinese are
manipulating their currency to gain advantage in international trade and this
is making many people angry.
The Japanese are
about to attempt the same. While the principles of a
currency’s exchange rate dictates that it should reflect the underlying
Balance of Payments, such moves clearly go against this. Perhaps we
should question whether the Balance of Payments should dictate an exchange
rate? Or should it be as in Asia, do what you can to support your
exports? If it is the former then the system of exchange rates as
we have relied on is giving way to expediency, a road with no
principles. In short, if expediency is the way forward then the
global system of exchange rates is under threat.
It is not simply
a case of manipulating ones economy to engineer a weakening of one’s
currency if you need to stimulate your own economy. Surely, this
also applies if you already have a strong economy.
In the case of
the U.S. the policy of benign neglect has led the U.S. into a situation that
will lead to a falling Dollar as it has a structural Trade deficit and has
watched its manufacturing slip away to China over the years. The
reality of this is now China can exert a huge influence over U.S. monetary
policy due to the huge investment it has in U.S. Treasuries. And
right now they are making moves to reduce this investment to the detriment of
the U.S.
The reality is
there is no set of rules that determine exchange rates in the world
economy. But you will find those who end up at a disadvantage
howling ‘foul’.
When Quantitative
Easing causes inflation
When the
‘credit crunch’ struck, money literally disappeared of the
balance sheets of banks and off those of individual investors.
Governments stepped in, in Europe and the U.S. and pumped in new money in an
attempt to fill those holes to keep the system going. Despite
this the credit crunch persists. Yes, the banks did fill these
holes and have made good profits through their trading activities, but the
impact on the broad economy is that bank lending was not
resuscitated. The state of the consumer and the broad economy in
the developed world tells us this. What’s more, the banks
have been pumping that money into Treasuries and making money
there. So the purpose of the QE is actually being defeated in the
States particularly. Certainly, no inflation is being seen in the U.S.
economy as a result of the QE. At least not yet! What
should happen is that the money supply should be expanded in conjunction with
job stimulation.
We take you back
to the Depression and the vast money expansion [QE] President Roosevelt
authorized through the revaluation and purchase of gold
thereafter. One of the ways he pulled the U.S. out of the
Depression was to employ the unemployed to dig holes and fill them in
again. Many thought this ridiculous, but what did it
do? It introduced that new money into the economy by expanding
the numbers of employed but most important of all it got the consumer
spending as the money supply expanded. The money did not go
in at the top but went in at the bottom to then filter up into the entire
economy. This got the entire economy going, not just the
banks. It wasn’t inflationary because it did not
simply add money to the system, it added spending consumers too.
It matched the expansion of the economy to the expansion of the money
supply.
Japan is a
different kettle of fish. It has suffered deflation for a decade
now. Its deflation has been absorbed by the economy and no
‘holes’ are there needing filling. New money in their
system, we believe, will lie on the surface of the economy [as they want it
to]. It will precipitate inflation. Once this
happens, savers will see little gain in holding depreciating cash and turn to
invest in assets, so as to protect the value of their
savings. They are not spending, but continue to
save. By doing that the flow of money in the economy is too slow.
We believe that
Japan is now about to walk that inflationary road to get the consumer
spending through lowering the value of his savings. The only
difficulty is that they have not done enough in this latest package to
achieve that, so expect more and soon, as the Yen continues to
rise. If they have success, you can be sure the U.S. will do the
same.
Why the Bank of
Japan’s stimuli is good for gold.
How can this be
good for gold? Put yourself into the shoes of the Japanese
investor. He has suffered deflation for so long he regularly
invests in other currencies to gain the interest rate differential as well as
the gain in foreign currencies over the Yen when it falls. With
the B of J telling these investors they want to lower the Yen, these
investors, when convinced this is about to happen, will follow this route
more enthusiastically.
If he believes
inflation is about to take off, he knows that in the present global
environment the B of J cannot afford to let interest rates rise [and take the
Yen with them]. He then realizes that the buying power of the Yen
is being reduced by such stimuli. Inevitably, once the Yen has been
undermined by QE, interest rates will eventually have to rise, to counter
excessive inflation. With this in mind both cash and fixed income
securities lose their attraction. A hard asset that cannot be
debauched is preferable. Locally this can be anything from
property to gold. The advantage of gold is that it is well known
to the Japanese and it travels all over the world. History also
shows that gold has proved itself the certain retainer of value in all
extreme times including both deflation and inflation.
In view of this
we believe that the Japanese will turn to gold, once they see the policies
intended to lower the Yen, working.
Julian
D. W. Phillips
Gold/Silver
Forecaster – Global Watch
GoldForecaster.com
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