As I write, at the end of the trading day in Tokyo, September 11, dollar/yen is at 106.95-96 and the Nikkei 225 average is at 15,909, up 120 yen for the day.
During the day the yen briefly broke through 107, setting a new YTD low at a level not seen for since September 25, 2008 in the immediate wake of the “Lehman shock.”
From 101.69 on August 8 the currency has been in virtually uninterrupted decline. Yen selling (and dollar buying) is said to reflect growing market confidence in an America economic recovery--and a likely Fed increase in interest rates.
The other side of this coin is an expectation that BoJ governor Kuroda Haruhiko will not be taking his foot off the monetary gas pedal and allow interest rates to rise in Japan.
Two days ago, on September 9, BoJ provided further evidence that it is not slackening in its “different dimension,” unprecedentedly aggressive and experimental program of quantitative easing (QE) in pursuit of 2% inflation. In the first transactions of this kind, BoJ purchased Japanese government bonds (JGBs) from banks at a negative interest rate. Buying in JGBs at a loss to the Central Bank is a way of force-feeding liquidity to the banking system, increasing incentives for lending for investment and consumption.
Today’s Nihon Keizai Shimbun on-line edition relates the commotion that erupted during the morning of September 9 on the bond dealing floor of a securities company when BoJ placed an order to buy JPY 500 billion (USD 4.7 billion) of short term JGBs.
“Negative interest rate” means, for example, that a bond with a face value, payable at maturity, of 100 yen would be traded at a price above 100 yen. BoJ’s current policy is “buying only,” i.e., just adding to its bond portfolio while injecting a steady flow of liquidity into the banking system. “Negative interest rate” buying means willingness incurring losses, clearly not “normal” commercial behavior.
The Nikkei article suggests that BoJ had wanted to avoid this drastic initiative. Kuroda seemingly concluded that the central objective of his “different dimension” QE policy--increasing the monetary base in Japan by JPY 60-70 trillion a year (doubling the base in two years)--would be unreachable without it. BoJ had been doing most of its buying at the long JGB end (some 50 trillion a year) where the market interest rate is slightly above 0.5%. The desire to achieve greater balance at the short end necessitated the negative rate buying operation.
Japanese stocks have on the whole been moving up in tandem with the weakening yen. At today’s close, the Nikkei 225 index well above its YTD low of 13,910 set on April 14 and seems likely to regain the YTD peak of 16,121 yen set on January 8.
But if rising stock prices are buoying sentiment, there is still great apprehension and doubt both within and outside Japan about the “real economy” effects of Abenomics. There is an uneasiness in the market about how much of the “Japan is back” story is illusory and likely to be temporary as one-off effects pass.
Launched in November 2012 and now having run for 449 business day, Abenomics’ most visible and substantially efficacious “achievement” has been the reversal of what had been a punishingly over-valued yen. From some 79 yen/dollar when Abe took office, this correction has been effected largely through the unprecedented size and scope of the Bank of Japan’s QE.
Last year stock prices of Japan’s globally actively companies surged, often doubling or tripling, reflecting dramatically increased yen earnings from export sales, the translation values of earnings kept overseas. This year, stock prices have risen more moderately, or in many cases declined.
This year what has attracted attention is how the devalued yen, reflected high consumer and industrial goods prices, has sapped purchasing power and reduced the relative value of yen financial assets.
One of the biggest surprises for the market (and much more so to academic economists) has been the failure of Japan’s exports to increase with the weaker yen. One explanation is that the many companies that moved production facilities abroad have continued to supply foreign markets through those overseas operations. That is, Japan’s manufacturing base has been fundamentally altered (“hollowed out” is not too strong a word), with domestic operations largely limited to supplying the domestic market.
After this geographic and operational restructuring of manufacturing capacity, the main effect of yen devaluation becomes trade deficits on the national level and rising living costs for households, as yen prices for essential energy, food, and material imports have increased.
Suffering are not just middle and lower income households. Between April and July this year the gap between the rise in the CPI index and the rate of return on bank deposits, in which Japan’s upper middle and rich typically hold much of their wealth, widened to 3%, a measure of wealth destruction not seen since “oil shock” in the 1970s.
How engineering inflation is supposed to improve living standards remains a mystery fathomable only by the brilliant minds in the world’s central banks. For the rest of us, it seems like madness. What is clear is that monetary policy can drive exchange rates. That Abenomics’ heavy reliance on cheapening the yen will produce positive medium term results seems an increasingly unlikely bet.
