Japan’s experience highlights the weaknesses of Quantitative Easing whilst Europe’s politicians do not believe in austerity for themselves

After a relatively quiet trading day in US equity markets yesterday with the Dow Jones Industrial Average falling 12 points to 11,113 we later saw the Japanese Nikkei fall by 163 points to 9202. Regular readers will know that one of the themes I have been following is the underperformance of the Japanese stock market over the spring/summer of this year. As the spread between the Nikkei and Dow Jones is now some 1911 points or 20.7% of the Nikkei’s value I can say that this is the widest gap I have seen during this period.

What is happening in Japan’s economy to cause this?

One factor has been the strength of the Yen exchange rate which has been very strong this year and in fact so strong that the Bank of Japan intervened in currency markets on the 15th September to try to stop its rise. This morning Yen strength has returned with it rising to 80.63 versus the US dollar,however in additon it is also now rising against the Euro having gained 1% overnight to 111.69. So we are getting something of a double-whammy effect today as recently Euro strength had been helping the Bank of Japan.

If we look at today’s economic statistics out of Japan we also see two worrying signs. One feature of Japanese life has been the way she has suffered from disinflation or falling prices at times in her “lost decade”, and one can add one more month to the list as September’s figures showed that consumer prices excluding fresh food (the Bank of Japan’s preferred measure) fell by 1.1% fmaking it 20 negative months in a row. To add to this industrial output fell 1.9 percent in September from August and a report was released suggesting that further falls in output are planned for this month.Whilst the unemployment rate did improve from 5.1% to 5% there are now concerns that this quarters economic growth may be negative rather than positive.


I have a section on Japan’s economic situation and this mornings figures are a reminder of the problems I have higlighted there. Japan seems unable to shake them off and if this situation persists then the longer-term problems she has will drag her down. For example she has an ageing and indeed shrinking population. Now long-term forecasts on this need to be taken with a pinch of salt but should current trends continue she will have a population that has fallen from around 130 million to 50 million at the turn of the next century. When you have a national debt to economic output ratio of over 200% such falls have strong implications for the future.

In reply the Bank of Japan is talking of more Quantitative Easing in spite of the fact that the QE it has enacted has had poor results at best. It plans for around 5 trillion Yen or US $61 billion worth but it seems simply too small to have much of an impact. Those who feel that QE affects asset prices will feel that perhaps the difference in scale between proposed QE between the US Fed. and the Bank of Japan is at least a partial explanation of differing stock market performance.

If you think about that then you are left with two unpleasant scenarios at this time. You have Japan with its chronic problems which it does not seem to be able to escape or you have the United States where its central bank is creating something of a false market in asset prices and ignoring the lesson that in the one country with real experience of QE it has not helped much if at all.

 A Currency Manipulation Index so trade sanctions can be brought against the US?

The Brazilian Finance Minister Mr. Mantega who came up with the phrase “currency wars” has come up with a new interesting thought. Mr. Mantega wants the International Monetary Fund to construct an index to measure who is manipulating their currency, in other words to identify who is keeping their currency artificially low to boost exports. To give you an idea of where he is heading let me quote his words.

In fact, the World Trade Organisation considers currency manipulation to be a commercial subsidy that has to be avoided and could result in sanctions.

So many countries are currently involved in currency manipulation that he is unlikely to succeed. As when the Financial Times tried to count them recently it counted 25, but it does highlight how the issue of currency wars are spreading. I wrote on the subject of echoes of the 1930s in this trend on the 23rd September and I have to confess the images and thoughts it inspires send a chill down my spine. I hope that the phrase history repeats itself is wrong.

The Peripheral Euro zone nations

There were further developments yesterday to follow-on from my update on this subject. For once Greece was not particularly the centre of attraction as her ten-year government bond yield only edged higher to 10.5%. However Irish government bond yields surged and whilst this coincided with a speech from her Prime Minister I do not think that this was the cause. The real cause came from an interview on RTE given by the Chairman of Anglo-Irish Bank in which he said.

Ireland needs a second state-owned bad bank, the chairman of Anglo-Irish Bank said today……………Mr Dukes said even after NAMA had finished its work, the banks would still be left with distressed assets.

Just to give you an idea of the scale of the potential problem estimates of commercial property lending which remains outside the first NAMA are around 70 billion Euros. Now if you factor into this that the Chairman of Anglo-Irish is plainly telling us there are problems with these loans then several issues arise. For a start Anglo-Irish was only restructured last month! I know that bad news from the Irish banking sector drips out slowly and we are never told the truth but this is a particularly poor development.

A second NAMA would have severe implications for Ireland as a sovereign nation and the burden she will have to carry for the forseeable future. I discussed on the 27th of this month that the Irish government has indicated that a further 15 billion Euros of fiscal austerity will be needed in the next four years. Well if the Chairman of Anglo-Irish is correct then that will be an under-estimate. The Irish government bond market fell heavily on the news following on from a poor week. The ten-year yield closed at 6.78% and the yield on her shortest maturity of November 2011 rose above 3% again to 3.19%. Sometimes the shortest dated maturities are the most revealing, particularly at a time of low official interest-rates.

Portugal’s government was to be found boasting that China might invest in its government bonds and that foreign investors now owned around 40% of her government bonds. Someone should perhaps point out to them that foreign investors usually invest as much for expected currency gains as for yield so should investors expect the Euro to drop he may not turn out to be quite so proud as they sell! Indeed the reality was that her ten-year government bond yield ignored such “success” and rose above 6% to 6.07%.

Europe’s problems with austerity

Having watched with a little bemusement at the way the European Parliament passed a bill for a 6.9% budget increase in a time of supposed  austerity, I had several thoughts. Firstly we plainly have elected a group of people to this Parliament who do not believe the current buzz-phrase of “we are all in it together”. Indeed they are showing signs of being even more out of touch that I thought they were…

However there is a darker thought. Are we being played Sir Humphrey Appleby style? Propose an increase of 6.9% which you do not really believe you will get,but  Jim Hacker, excuse me Europe’s politician’s can appear fiscally austere by restricting you and you end up with a still much too high 2.9%%! So the bureaucrats get pretty much what they want and the politician’s can make some soundbites and the music plays with Sir Humphrey ending the episode with the usual refrain of “Yes Minister.” Everybody in the episode is happy that the obvious objective of no increase at all has been safely ignored. Oh everybody but the hard-pressed taxpayers of Europe who are likely to find themselves paying yet higher sums to individuals who sometimes are exempt from tax.

Meanwhile back in the real world unemployment in the Euro zone rose to 10.1% with a further 67,000 jobs being lost in September. Just to add to the gloom inflation rose to 1.9% as well. German retail sales also fell 2.3% in September but caution is required here as retail sales can be an erratic series.


7 thoughts on “Japan’s experience highlights the weaknesses of Quantitative Easing whilst Europe’s politicians do not believe in austerity for themselves

  1. Hi Shaun. I am sorry that we could not enjoy a quiet drink after the up coming test match. If your lack of confidence in your coach is unfounded and you should happen to fluke a win I will have to raise a toast to your hero who was a mighty fine player in his day. You may not know it that he played a lot out here as a junior and it was no surprise to us that he went on to be one of your best.
    Looking at the Northern economies from a distance is a bit like watching a car crash in slow motion. As you often point out Japan has to a certain extent been the failure that should not be followed. However the US and the UK seem hell bent on repeating Japan’s mistakes.
    One of the most remarkable themes that is playing out is the lack of truth or insight from the mainstream media. It is therefore very important that knowledgeable people like yourself have a voice and speak out. Some of us appreciate the truth or at the very least questioning what we are told is the truth.
    Do you you ever contemplate where this is all going to end up? (Apparently we are all in this together!) I would be interested in your view of what the world might look like in say 10 to 20 years time if the themes you have been commenting on continue to play out. I get the feeling that we are indeed living in very interesting times.

    • Hi Bones
      As we are on opposite sides of the world we could not literally raise a glass but I am more than happy to in spirit so to speak! I assume you support the All Blacks and from what I saw yesterday they were playing well but I had to go and sort out a problem with my car and was surprised to discover you lost. I did know that MJ had played out there and I believe married a kiwi which was funny at times when your media abused him of hating Kiwis….

      As to your question yes I do and some strands do come together but others are shrouded in fog. For example one of my themes particularly for the UK is that inflation is an issue particularly if you use the RPI measure or the GDP implied deflator. If you add to this that the numbers we have now follow a severe recession then they show a danger as to fit the story of those who disagree with me they needed to be lower I feel. This leads me to have concerns about what will happen in a recovery…
      If you add to this that we have the US FOMC which appears set on more QE and an MPC in the UK where there are supporters of this too then a clear danger is printing money leading to inflation. Now for some on the FOMC this is an outright objective and they are of course entitled to their view. However I feel that the US CPI is a very poor measure of inflation even worse than the HICP used in Europe and the UK so the “real” measures will increase as a result of this. We will get a test of the FOMC this week because if you take the last 2 quarters of growth in the US which have been 0.4% and 0.5% you do not get a justification for more QE in them. But I suspect we will get an expanded version of QE lite this week sayx4 as an opening salvo.

      So we get central banks who appear to want to ease with inflationary issues around. This bothers me for the US but a lot more for the UK.

      To address the deflation argument if you go through my articles I have never assumed that it has to come with disinflation. We could get no-growth or slow growth with inflation. Actually I believe that over the timescale you are asking for what is being done now makes something like the 1930s more and not less likely… Shireblogger made the point that the US FOMC has an employment objective and he is right but to address that I again I do not believe that more QE will help with this much if at all. The argument you have to do something should always in my view come with the extra bit that you only do something which you believe will work.

      Now if you factor in that I believe that banking systems are in a much worse position than we have been told we now have 2 contrary strands. I feel that Ireland has been revealing not in the way that is usually presented as stimulus versus austerity. I see it as an example of weak cronyism-type politicians revealing bad news in small packets over time. I fear that this is true of other banking systems too and that the UK US and Europe have not recovered anything like as much as you might assume from their share price. Another false market if you like.

      If you put my two themes together then the next 6 months has a lot of alternatives so I am afraid that 10/20 years ahead is shrouded in fog. We need reform of many areas desparately but are no nearer getting it.

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