Friday, November 14, 2014

Japan quantitative easing and trade wars?

My favourite flavour has always been geo-politics, I was never comfortable with pure economics, because economics is not really a science (sorry dad & Sis and mom too).  Using complex model that make massive behavioural assumption is a recipe for disaster...  case and point Japan.

Over the past 24 months the Japanese government has begun a massive inflation drive, and a massive devaluation push.  The Yen went from 90 to 110 to the dollar, but the impact on regional currencies has been even more dramatic.  Japan's objective is to create inflation -- so far its been unsuccessful. The means has been massive quantitative easing (e.g. government prints money) and with this cash they have been buying assets -- lots and lots of assets; MBS, bonds (short and long) stocks in a nutshell the Japanese government has depressed the printing button and have been printing Yens like crazy.  In the past 12 months they have issued $750 billion in new money - slightly more than what the US treasury did in 2008, but Japan's economy is a fraction of America's.  Its as if, every year, the US treasury injected US$ 3 trillion per annum.  The idea is that all this money will create inflation -- yes inflation did occur in May 2014 -- but 100% of this rise has been due to rise in sales taxes!! So that policy has not worked.

However, this massive cash injection has done three real things -- it has weakened the currency, its has increase government deficit and it has lead to a massive rise in the value of stocks.  For traders and investors this has been a one way sure thing.  The dominant trade of 2014 is"long Japan short yen" -- it has been one of the most profitable trade of all time.

Now, the impact to the real economy is something else.  First, as the region slows down (demand for goods produced in Japan -- or elsewhere) has slowed.  Excess labor in Japan -- despite a rapid population aging (and the corollary drop in working age population) has generated under-employment and income collapse, over the past 12 months income has shrunk by nearly 6%.

Despite the weaker yen (about 25%) industrial production is in free fall, because Japan's largest and most consistent market for goods and products is:  JAPAN!  A collapse in income means that demand has fallen.  The three pillars of Prime Minister Abe's have worked to weaken demand.  In a nutshell aside from traders and investors this strategy has been not only unproductive but has destroyed real economic value in Japan.

The prime minister's action were driven by a desire to re-create the Japan of the 70s where, like China, Japan's economic growth was driven by exports -- a cheaper yen and loose monetary policy should have been helpful, except that its target markets (Asia) have identical strategy -- grow through exports.  Despite what many commentators say, its impossible for everyone to be a net exporter.  The regional consequences here could be severe;  The risk here is to currency war and possibly a trade war.

That's serious