Solving the Japan Conundrum
by George Hatjoullis
The BoJ announced it will pay a negative interest rate of -0.1% (to banks) on all new bank reserve deposits. Existing reserve deposits will continue to earn +0.1%. In the short-term this will have little impact other than the symbolic impact of conceding negative interest rates. If the BoJ looks up across the globe at other countries that have resorted to negative rates it must surely conclude that this will make little difference to the Japan problem. Negative interest rates are a symptom of a deflationary environment not a cure. Japan has a huge public sector debt, much owned by the BoJ, and the BoJ continues to buy government debt. Yet deflation remains a problem. I wonder how long it is possible to keep doing the same thing and expecting a different result. Japan may be setting a record.
There is only one way to solve the Japan conundrum and this is through monetary financing. This blog has argued so since the inception of the blog in the spring of 2013. I may be setting a record on how often someone can repeat themselves and in how many different ways and still be ignored. It is a conclusion at which the BoJ will eventually arrive. The question is what might force their hand? The Yen had been rallying recently and it has been suggested that this negative rate surprise was triggered by the desire to reverse and halt this rally. If so, it will be a short-lived victory.
The above chart of DollarYen suggests it was heading towards 110. Such a move would have been most unwelcome to the Japan authorities. Indeed it could have been calamitous.The problem is that unless DollarYen now climbs above 124 it will most likely resume the path to 110 or thereabouts. The overnight move was caused by a short squeeze. It was not a fundamental or technical change of perspective. It is hard to conjure any scenario now that has the Yen weakening further from present levels, except that is, monetary financing. The catalyst for a dramatic policy shift may thus be the Yen.
If the Yen rallies before the Japan economy has shaken off its deflationary bias then a deeper and more pernicious deflation beckons. The limit of conventional monetary policy has been reached. All that remains is monetary financing. Given the context of the global economy it is difficult to see any inflationary impulse (outside of global war). It would take a massive jump in Japan consumer spending and/or corporate investment to negate this view. It would be best if the BoJ came to this conclusion and organised a considered move towards monetary financing. To be forced into it through extreme circumstances carries huge risks.
I have explained monetary financing several times and in different ways throughout the blog. For those that find it more convincing if somebody ‘official’ does it try: