Yen: Getting Harder to Ease

Tue, May 10, 2016 - 9:06am

If you want the bank to hold your money in Japan, it will cost you. In fact, any bond an investor buys up to a 10-year duration carries a negative interest rate. Japan has been the most aggressive first world country on the planet printing currency out of thin air as they engage in quantitative easing (QE). Using their digital printing press and decimal point dexterity, the Bank of Japan (BOJ) has been creating 3 Billion (80 Trillion Yen) annually to buy Japanese bonds and stocks. Relative to the size of their economy, such a rapacious appetite would equate to almost .9 Trillion annually in the US or about triple our peak rate of QE. The BOJ has purchased Japanese Government Bonds (JGB’s) at twice the rate of issuance. Running out of things to buy with this free money, they have now become a top ten shareholder in 90% of all stocks in the Nikkei 225 Stock Index. With limited ability to keep buying assets combined with a rally in Oil, the Yen has begun to appreciate sharply since January. At 250% debt to GDP, Japan is in so deep now that there is no chance they will grow fast enough to pay down this unsustainable debt burden. They are all in! Japan and the world are crossing their fingers that the old global rates of consumption and inflation will return to the halcyon days of the 1990’s. More likely is a panic run on the currency as the BOJ will continue using QE and currency intervention until either their economy accelerates or the markets finally lose confidence and moves to hard assets. For now, the game continues and as long as Oil stops rallying, the aggressive QE should send the Yen lower once again.

Read Global Liquidity Update - Japan, Euro Area, and Emerging Markets All Negative

Why does Japan need a lower Yen value? A cheaper Yen value relative to its major trading partners is a textbook formula to stimulate exports and the animal spirits of inflation. Printing more Yen and buying assets would historically achieve this goal. In a world of aging demographics and excess debt, we have proof that Government and Central Bank meddling is outmatched by the force of the free market.

Oil Rally Allows Carry Trade Divergence

Normally a falling Yen in sync with negative Japanese interest rate trends lead to rising carry trade capital flows into the stock market as the falling Yen seeks higher returns. It doesn’t hurt that the BOJ uses an unlimited virtual money to usurp major ownership of hundreds of Japanese companies. Note below how the falling Yen value (rising green line) has correlated well with rising US (& Japanese) stock prices. When Oil bottomed at a barrel in January there was a sharp divergence in this relationship as the carry trade subsided. If Oil weakens once again then stocks and Yen values should decline.

Yen Sentiment Overbought

Yen values rose in the first quarter despite massive printing of Yen currency, QE asset purchases, and negative interest rates. Why would anyone want to buy Japanese bonds with negative rates and sell US Bonds with relatively high yields? Investors buy negative yields expecting even lower yields for capital appreciation of the underlying bond. The rally in Oil priced in US dollars supported this move, but now the smart money of Commercial traders have sold their long Yen holdings and moved to one of the largest net short positions ever. Large speculators are extremely Bullish with their near record high net long positions indicating a Yen top is at hand. As with the stock market, we should keep our eye on Oil prices since new highs above /barrel will send stocks and Yen values higher once again.

Free Money and Still No Inflation!

Other than a couple spikes in energy prices boosting Japanese inflation, it doesn’t seem to matter how much stimulus Japan introduces. They spend massively on public works programs and infrastructure, print money to induce financial speculation and send borrowing rates beyond free. Yet Japans consumer price index just falls right back into “deflation”.

The reason for almost 3 decades of no long-term Japanese inflation is the same reason massive stimulus has failed to inflate the world economy since the 2008 Great Recession: Demographics. The bulge in aging populations reduced consumption rates and income growth. The ratio of retirees to prime working age adults is becoming more lopsided. Japan’s senility boom preceded other major countries by a decade or two and remains in secular decline.

Should India, Brazil and other younger countries acquire the Governmental and physical infrastructure to take advantage of their demographic superiority in the marketplace, then we may see a new world boom take hold between the early 2020’s and early 2030’s. For now, we can expect more of the same from aging wealthy countries trying to stimulate the last borrowed Dollar to relive their misspent youth while crossing their fingers that sovereign debt bubbles can avoid contact with the arrows of speculation.

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