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Just when I thought I was out, they pulled me back in.
Into a global liquidity push, that is. Even as other central banks are very slowly heading for the exits (again?), the Bank of Japan last week unleashed some ¥28,000bn of liquidity as it sought to avert an earthquake-sparked credit crunch.
Now, net numbers are a bit less than the headline figure, though they’re still fairly huge. The Bank of Japan’s current account ballooned by ¥15,000bn last week.
Big figures, yes.
But there are some who think the BoJ could do even more. Bank of America Merrill Lynch’s Bin Gao, for instance, thinks the bank could basically print money to buy foreign assets. It’s a controversial theory to be sure, but an intriguing one.
Here’s his reasoning:
Through the years, the problem troubling Japan has been deflation and the strong currency only multiplies the double whammy of hurting exports and furthering deflation. Demographics have been cited as a factor for deflation but no textbook says that one cannot get inflation with negative population growth. The problem lies with the method and/or the justification for currency debasing. Fundamentally, it seems that the BoJ does not trust that the government was getting things right and, at more than 200% debt to GDP, it was reluctant to monetize the government debt further. That would be a wrong way to debase the currency.
A weaker yen is surely in Japan's interest. With the G7 agreement for currency intervention, an opportunity is created for the BoJ. It was reported in Reuters that the intervention will be unsterilized, though this has not been confirmed. There has also been a report that the government will directly issue ¥10tn of JGBs to BoJ, though it was also denied by the government, saying there needs to be a "cautious debate". Given the high debt to GDP, the advantage with the former approach is obvious, more liquidity, weaker currency, and higher imported inflation. Such an obvious outcome was not implementable in the past due to the fear and accusation of currency manipulation, but the opportunity just opened up for the BoJ to not be worried about such issues at least for the near term with G7 agreement in currency intervention.
Size of the balance sheet poses no concern. There will obviously be criticism of this approach on how Japan can afford to print money with so much government debt already. The beauty lies here. It will only expand the BoJ's balance sheet not the government’s, at least not directly. Investors should draw clear distinction between the two. As it stands now, the BoJ's balance sheet is about 27% of Japan's GDP, while that of the Federal Reserve still comes around only 17% of the US GDP. But the BoJ's balance sheet is lower than the 31% peak during the previous QE period; it barely holds any foreign assets (¥5tn out of ¥130tn). Most of Japan's FX reserve to the tune of ¥1tn is in the hands of MoF. So we think it would be perfect for the BoJ to buy USD in the market while the MoF can sell to raise funds. If the market becomes too concerned about the size of BoJ's balance sheet, just look east to the economy which just took over Japan as the number two in the world. The central bank of that country has a balance sheet standing at 68% of the GDP, 83% which consists of foreign assets, and no one seems to be too concerned!
A convenient excuse to do something that certain corners of the Japanese political system (and analysts) have been pressing the BoJ to do for some time, then.
Watch what happens.
Related links: BoJ’s current account is set to expand - WSJ The Bank of Japan "“ almost back to 2004 numbers - FT Alphaville What’s moving the yen? – FT Alphaville
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