Japan and Abeconomics: target 2-in-2
by George Hatjoullis
The previous post on Japan and Abeconomics suggested that Japan should consider debt cancellation (or equivalent) as the central pillar of monetary policy. The idea has a good pedigree as Peter Tasker noted yesterday in the FT (http://on.ft.com/XYkdTC). Korekiyo Takahashi adopted this policy between 1931 and 1936 and successfully saved Japan from the global depression.
The Bank of Japan has stopped short of debt cancellation but has done the next best thing (http://bit.ly/10cipJJ). It has voted, almost unanimously, to target 2% inflation in two years and to achieve this via a doubling of the stock of fiat money. This is to be achieved by aggressive quantitative easing including the purchase of very long dated Japan government bonds. Will this work?
Well it might. It is far more aggressive than the markets expected though dollar/yen has still to make a new local high. The yen should now resume its path of trend depreciation that began last autumn. It will also boost the Japan stock market, which is where much of this liquidity will end up. It will cap JGB yields. The combination of yen depreciation and stock market appreciation alone may be sufficient to break the grip of structurally negative inflation expectations and yield the necessary effect of 2% achieved inflation in two years.
However, it is not inevitable. Deflation expectations are entrenched in Japan. The experience of, not unaggressive, quantitative easing in the USA and UK has been less inflationary than one might have expected and many feared. Moreover, in the USA and the UK, it would be hard to argue that deflationary expectations were ever really evident. So a well done to Abe and the BoJ. They have given it their best shot within the conventional parameters of monetary policy. However, no prize as yet.
It is not difficult to see dollar/yen breaching 100 and trading up as far as 105. Beyond these levels may cause some concern at the BoJ, where they would most likely prefer the currency pair to settle at around a 100. Unfortunately currencies are rarely this accommodating. Once the momentum builds dollar/yen could end up back at 120. Ironically it is this ‘overshoot’ that will most likely ensure the BoJ achieve its 2-in-2 target. Japan stocks being quite correlated with the dollar/yen rate, the parallel move should be at least 18000, or about another 40%, for the Nikkei 225. Nice work if you can get it.