"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, March 16, 2011

Additional thoughts on the Yen and the Bank of Japan

There is growing speculation that the Bank of Japan is going to soon start up its own rollout of Quantitative Easing, Phase Two. Some might recall that the very phrase, QE, owes its familiarity to efforts by the BOJ to counteract the deflationary pressures afflicting its economy during the 1990's. In the early part of the next decade, the BOJ, having already reduced interest rates to effectively zero, began buying up its own government debt as well as its agency debt and even equities in an attempt to liquify its economy and stimulate both borrowing and lending. The effort was aimed at securing precisely the same thing that the Fed under Bernanke's leadership is attempting, namely, increasing inflation and inflation expectations to stave off a deflationary mindset.

Regardless of whether one judges that effort successful or not, it is the only viable option left for a Central Bank once it has knocked short term interest rates to zero. After all, the term "zero bound" means something or it means nothing at all. To move further out along the yield curve and reduce interest rates there requires another type of Central Bank "tool" (as Ben Bernanke would term it). That tool is QE.

Given the fact that interest rates in Japan remain chronically low due to the rather tepid rate of economic growth that the nation has been experiencing, the BOJ has really no effective options at this point to attempt to cushion the economy there from the impact of the dreadful earthquake, tsunami and nuclear trifecta which has crushed the nation at a time it could least afford it.

I suspect therefore that the BOJ is going to engage in the same strategy currently being employed by the Federal Reserve here in the US and will shortly announce the commencement of another wave of QE.

This will serve two purposes - or at least it should in theory. First, it will lower longer term interest rates in Japan (not that they were high to begin with) and flood the big banks there with huge sums of cash pumping up reserves and theoretically making lending more affordable for reconstruction purposes. Two - it should serve to undermine the Yen and knock its value down on the global currency markets.

Remember what happened to the US Dollar when the Fed commenced its QE program in March 2009? - it undercut any strength in the greenback that was gained when it experienced a massive rally after the credit crisis erupted in 2008. The Dollar became the go to currency during that time as US stocks and commodities in general were slammed lower jacking up the value of the US currency and slowing down US exports at the very time that policy makers were attempting to generate some sort of economic activity in the US economy. QE put a dagger through the heart of that Dollar rally and has effectively acted to keep a lid on it ever since.

If what I believe is going to happen does, namely a BOJ version of QE, it should tend to depress the value of the Yen which has been bid up to what can only be termed "irrational levels" by panicing speculators unwinding carry trades. The Bank of Japan simply cannot allow the specs to take the Yen any higher without crippling attempts to ameliorate the damage done to the economy there by the earthquake-related tragedy.

Whether or not they actively intervene in the foreign exchange markets this evening or soon thereafter, they are going to attempt to drive the Yen lower.
Once again we get a bird's eye view of history unfolding. 


  1. ah! the birds eye view

    were it so such a distance might be maintained--away from the sweat and grime, above the carnage, viewed at a safe enough distance to take in the panorama of destruction and desolation

  2. Great stuff, Dan.
    If the BoJ is able to halt and turn back the advance of the yen, perhaps it will be time to buy the dip. We'll see.

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  4. Good analysis Dan. Correct me if I am wrong, but if a Reserve Bank sets negative interest rates (has this ever been done?) then people will know without doubt that they are in the gun to 'pay' a bank the privilege of holding their funds. Their money essentially decreases in purchasing power because it gets sifoned off with the interest payments. A form 'taking' from Joe Sixpack that he can understand. Whereas, inflation by QE is a way of stealing Joe's money without him knowing.

    I guess that's why, politically, they don't opt for negative rates?

  5. Dan
    Once again you demonstrate that your blog is the most valuable asset on the web. Great work and thanks for sharing your intelligence.


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