The issue this week was the meeting of the Bank of Japan where they debated what to do about a Yen strong enough to damage Japanese exports, the mainstay of the Japanese economy. It was agreed that Japan will spend 920 billion yen [$10.8 billion] on economic stimulus and compile an extra budget if needed. The central bank expanded a loan program by 10 trillion yen [$116 billion]. This left the market underwhelmed and the Yen went stronger still. This was a red rag to a bull as it invited speculators to push the Yen even higher. They will keep pushing it up until the B of J takes sufficient action to prevent its rise. The talk is now that it will rise to around Yen 78 against the U.S. Dollar, which will force crisis action on the government. But far more than meets the eye lies in this action and potential action.
- It attacks the reasoning behind Exchange Rates
- It encourages speculation both on the Yen and, unlike the U.S. does not fill the holes caused by deflation but devalues the buying power of the Yen with an inflationary stimulus.
Both these actions undermine Japanese money internally and externally.
Exchange Rate Determination Rules
If no one objects to this, then a tacit approval of this policy is being given. If this is the case, then you can be sure that other major nations will follow suit. What of price stability and exchange rates that accurately reflect the Balance of Payments of a nation. To understand the importance of these issues we take you back to the last time you heard the U.S. complain about the undervaluation of the Chinese Yuan. It is perceived by many in government and in both parties that the Chinese are manipulating their currency to gain advantage in international trade and this is making many people angry.
The Japanese are about to attempt the same. While the principles of a currency's exchange rate dictates that it should reflect the underlying Balance of Payments, such moves clearly go against this. Perhaps we should question whether the Balance of Payments should dictate an exchange rate? Or should it be as in Asia, do what you can to support your exports? If it is the former then the system of exchange rates as we have relied on is giving way to expediency, a road with no principles. In short, if expediency is the way forward then the global system of exchange rates is under threat.
It is not simply a case of manipulating ones economy to engineer a weakening of one's currency if you need to stimulate your own economy. Surely, this also applies if you already have a strong economy.
In the case of the U.S. the policy of benign neglect has led the U.S. into a situation that will lead to a falling Dollar as it has a structural Trade deficit and has watched its manufacturing slip away to China over the years. The reality of this is now China can exert a huge influence over U.S. monetary policy due to the huge investment it has in U.S. Treasuries. And right now they are making moves to reduce this investment to the detriment of the U.S.
The reality is there is no set of rules that determine exchange rates in the world economy. But you will find those who end up at a disadvantage howling 'foul'.
When Quantitative Easing causes inflation
When the 'credit crunch' struck, money literally disappeared of the balance sheets of banks and off those of individual investors. Governments stepped in, in Europe and the U.S. and pumped in new money in an attempt to fill those holes to keep the system going. Despite this the credit crunch persists. Yes, the banks did fill these holes and have made good profits through their trading activities, but the impact on the broad economy is that bank lending was not resuscitated. The state of the consumer and the broad economy in the developed world tells us this. What's more, the banks have been pumping that money into Treasuries and making money there. So the purpose of the QE is actually being defeated in the States particularly. Certainly, no inflation is being seen in the U.S. economy as a result of the QE. At least not yet! What should happenis that the money supply should be expanded in conjunction with job stimulation.
We take you back to the Depression and the vast money expansion [QE] President Roosevelt authorized through the revaluation and purchase of gold thereafter. One of the ways he pulled the U.S. out of the Depression was to employ the unemployed to dig holes and fill them in again. Many thought this ridiculous, but what did it do? It introduced that new money into the economy by expanding the numbers of employed but most important of all it got the consumer spending as the money supply expanded. The money did not go in at the top but went in at the bottom to then filter up into the entire economy. This got the entire economy going, not just the banks. It wasn't inflationary because it did not simply add money to the system, it added spending consumers too. It matched the expansion of the economy to the expansion of the money supply.
Japan is a different kettle of fish. It has suffered deflation for a decade now. Its deflation has been absorbed by the economy and no 'holes' are there needing filling. New money in their system, we believe, will lie on the surface of the economy [as they want it to]. It will precipitate inflation. Once this happens, savers will see little gain in holding depreciating cash and turn to invest in assets, so as to protect the value of their savings. They are not spending, but continue to save. By doing that the flow of money in the economy is too slow.
We believe that Japan is now about to walk that inflationary road to get the consumer spending through lowering the value of his savings. The only difficulty is that they have not done enough in this latest package to achieve that, so expect more and soon, as the Yen continues to rise. If they have success, you can be sure the U.S. will do the same.
Why the Bank of Japan's stimuli is good for gold.
How can this be good for gold? Put yourself into the shoes of the Japanese investor. He has suffered deflation for so long he regularly invests in other currencies to gain the interest rate differential as well as the gain in foreign currencies over the Yen when it falls. With the B of J telling these investors they want to lower the Yen, these investors, when convinced this is about to happen, will follow this route more enthusiastically.
If he believes inflation is about to take off, he knows that in the present global environment the B of J cannot afford to let interest rates rise [and take the Yen with them]. He then realizes that the buying power of the Yen is being reduced by such stimuli. Inevitably, once the Yen has been undermined by QE, interest rates will eventually have to rise, to counter excessive inflation. With this in mind both cash and fixed income securities lose their attraction. A hard asset that cannot be debauched is preferable. Locally this can be anything from property to gold. The advantage of gold is that it is well known to the Japanese and it travels all over the world. History also shows that gold has proved itself the certain retainer of value in all extreme times including both deflation and inflation.
In view of this we believe that the Japanese will turn to gold, once they see the policies intended to lower the Yen, working.
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