Japan’s Economy: The Test Tube Baby for Monetary Policy

Here’s a question: if the machines and bots have largely taken over the share market, why did the New York Stock Exchange close for weather-related reasons two days in a row? It’s the first time the NYSE has done that since the 1880s, way back in the 19th century. Maybe this will be a dry run for markets that operate without physical trading floors.

Buried in the avalanche of Hurricane Sandy news was a tid bit from Japan. Japan’s economy, of course, is the test tube baby for monetary policy in a zero growth environment. If you want to know what happens to an economy when the central bank takes over in the aftermath of a collapsed bubble, you have to look at Japan.

Yesterday, the Bank of Japan lowered its growth forecast for the Japanese economy. It said that, ‘Japan’s economy has been weakening somewhat.’ It said exports and output were weaker than expected. Yet all of that lethargic news was more or less expected.

Credit junkies were hoping the BoJ would take the weak growth figures and turn it into fresh new monetary smack. Specifically, traders were looking for Japan to expand its asset purchase program. And Japan DID expand the program, but not by as much as the market had hoped, judging by stock market numbers.

Japanese stocks were down. The Nikkei 225 closed at 8841. That’s still quite a ways from 38,916, the all-time high in December of 1989. It’s going to take a lot more than the $1.4 trillion in new asset purchases the BoJ announced yesterday to reflate Japanese stocks.

The really interesting detail in yesterday’s announcement is that asset purchases would expand to include exchange traded funds and real estate investment trusts. These are ‘risk assets’. Normally, these asset purchases programs are confined to government bonds in order to keep interest rates (the cost of credit) down in the economy. The BoJ is experimenting with asset creep.

But you’ll notice Japan’s stock market made its high 23 years ago. Ever since then, the people who spend money (fiscal policy) and the people who print money (the Bank of Japan) have tried every trick in the book to reflate the stock market and real estate sector. It has made a fat lot of difference.

Japan’s economy continues to chug along. High savings rates have allowed for a world-class government-debt-to-GDP ratio of over 200%. But the little tiff with China over disputed territory in the East China Sea has affected exports over the last few months. The last thing Japan’s economy needs is a trade war with one of its biggest trading partners.

But our main point is that asset purchases don’t fix an economy where a debt bubble has burst. It’s like using a balloon to pound a nail, the wrong tool for the job. The Fed has been making the same mistake in the US since the bursting of the Internet bubble. Blowing up one bubble after another in an attempt to reflate financial asset values has done exactly nothing to create US manufacturing jobs, although it did put a lot of real estate brokers to work for about four years.

For investors, the disturbing news is that central bank crack hits aren’t moving markets the way they used to. Part of this is sentiment. The rush investors get when a big new money printing binge is announced is what leads to purchasing ‘risk assets’. But if the purchases aren’t sufficiently large enough to make portfolio managers swoon, stocks limp along.

The other more practical reason the money printers are struggling to move stocks is that in a large, debt-based system, the debt must continually expand to prevent asset prices from falling. If debt is paid off, or extinguished, money disappears from the system. To prevent that contraction, credit must continually expand.

The real fight right now is between central banks and falling asset prices. Can the bankers create new money or monetise debts and assets faster than the rate of wealth destruction in the financial system? To inflate or die, that is the question!


Dan Denning
for Markets and Money

From the Archives…

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The Lost Generation in the US Economy
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Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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