The US economy has also bared the brunt of this strong dollar resulting in a decline in corporate earnings, the loss of jobs via US shale, and a widening trade deficit. It is now quite apparent that the Obama administration isn’t going to tolerate this strong dollar any longer. The US put China, Germany, Japan on a watch list for FX manipulation. And if that wasn’t enough, President Obama AND Vice President Biden both met with Yellen after the Fed held an emergency meeting on interest rates just a few weeks ago. Once you add in Obama’s concern for his legacy for reviving America’s post crisis economy, and the picture becomes quite clear.
Unfortunately a weaker dollar translates into a stronger Euro and Yen. Unfortunately, both the Euro and the Yen never weakened enough to begin with and any move higher from here will be come at a great cost to their economies.
I believe that Japan will be the first of these economies to break ranks and head for a weaker currency through open manipulation which will most likely ring the bell for the next round of the currency war.
In our current currency war, the first round of competitive devaluations were done under the guise of “stimulus”, but now that QE has failed to stimulate the economies in both Europe and Japan, this excuse will no longer be acceptable both from a political and an economic point of view.
It took a while but now it seems the majority of people are ready to admit that monetary policy alone is not enough to stimulate growth. Governments must get in the act. Although this is foolish thinking, because one only needs to look at the failure of Abenomics’ three arrows to see that the problem is too much debt and the idea that governments aren’t doing their part to stimulate demand is misplaced.
Eventually, somewhere down the line, debt will need to be forgiven, but we are not there yet. I think we will need to have as Raoul Pal calls it “a bonfire for the central planning vanities” where citizens will cede complete control over economic planning to central institutions so that they can once and for all prove to the world and history that they are not capable of creating sustainable growth. Only after this final folly can we start to rebuild what was lost, and add another tally in the column of free markets which hopefully won’t be ignored next time.
Getting back to Japan, the point is that the BOJ has failed to stimulate the economy with its current toolkit. QE, QQE and NIRP are no longer producing the intended effects. The BOJ cannot reasonably increase its purchase program because it will absorb too much of the remaining JGBs. The remaining JGBs which a large portion of them are trapped on bank and pension balance sheets due to regulations. Thus the amount of JGBs truly available for purchase are smaller than people realize, which magnifies the BOJs current conundrum: Where are they going to find the bonds?
The answer is the Japanese government should issue a poop ton of debt by expanding the deficit even further with the BOJ monetizing every last bit. Unfortunately with Japanese government debt to GDP at +220%, it seems silly to think that the answer to Japan’s problems are for the government to issue even more debt. But hey, logic be damned we are having a bonfire!
It’s hard to tell when people will start to worry about Japan’s ability to pay back its debt. Some time during the aforementioned bonfire would be my guess.
But let’s say, the Japanese government doesn’t have the power or leeway to rapidly expand the fiscal deficit in the short term. That would mean that once again it all falls on the unelected members of the BOJ who don’t have the current tools to devalue the Yen.
As stated earlier QQE and NIRP are not having their desired effects. The Yen has rallied in the face of collapsing bond yields – a deadly deflationary mix for Japan’s demographic depression. The only possibly way in my mind, for the BOJ to fight this deflation would be through direct currency intervention.
Using ball park estimates I’d think the BOJ should try and get the USDJPY to 120 by the end of the year on its way to 140-150 over the next few years. Do I think this is the sensible long term thing to do? No, but it’s what I think the BOJ should and would do if it wants to preserve short term stability regardless of the cost of stability in the long term.
The BOJs drastic intervention in the FX market could spark a similar response to NIRP, when the market responded with fear instead of jubilation. And let’s not forget that the geopolitical responses to such a measure although unclear would most likely have detrimental effects to global trade and ring the bell for the next round of the currency war to commence.
The extreme and overt nature of currency manipulation is indicative of the challenges that central bankers are faced with. Forced to manage the world’s floating exchange rates at a time when currency volatility is hitting multi year highs, central bankers are like high wire artists pushed further out on an ever narrowing tight rope with no end in sight.