I don’t think I have seen a single piece of positive commentary about Japan’s recent surprise move to negative interest rates (Expert Liars). In fact, most strategists believe it was colossal mistake. Not only does it encourage the hoarding of cash (which is deflationary), it has also failed to achieve the intended effect of a lower Japanese Yen. On the initial announcement we saw some Yen selling, but since then it has been a one way freight train higher.
What was Kuroda thinking? Why did he pursue this path?
To understand why Kuroda ventured into the land of negative rates, all you need to do is look at the Bank of Japan’s balance sheet. Here is a chart of the BoJ Balance Sheet as a percent of GDP over the past decade and a half:
Before Abeconomics the ratio hovered between 20% and 30% of GDP. However over the past three years the Bank of Japan has expanded their balance sheet from 30% to 75%! This is in contrast to the Federal Reserve running below 30% and the ECB just approaching 20%.
The Japanese have been running the printing press flat out, with expansion at this rate priced into the market for the foreseeable future. Given the massively deflationary forces being unleashed on the world from the Federal Reserve’s brain dead tightening, the Bank of Japan either had to admit failure to achieve their inflation target, or try to somehow ease further.
Expanding the rate of Quantitative Easing would be problematic for Kuroda. The Bank of Japan is already almost monetizing the entire new issuance of JGBs every month. With their expansion to risk assets, the BoJ owns almost 50% of all the Japanese equity ETFs outstanding. Increasing quantitative easing was simply not a good option.
Therefore given the ECB’s moronic move to negative rates last year, following that path was the easiest form of easing Kuroda could enact.
Negative rates are just bat shit crazy
I have said it way too many times, but monetizing your balance sheet with equities and other risk assets, and when that doesn’t work, moving rates to negative levels is just bat shit crazy. How is a financial system supposed to function with negative rates? Someone please tell me what risk free discount rate you should use in your models? As the risk free rate approaches 0% many models accelerate towards infinity. What happens with negative rates? How do you go beyond infinity?
When faced with these unprecedented Central Bank shenanigans, many investors are simply stuffing their hands in their pockets. Risking money takes a certain amount of faith in the system. This faith is sorely lacking, and it is getting worse.
The answer is actually fairly easy
The solution to this problem is not that difficult. Economies are missing real demand. It’s at a time like this governments should step up and fill that void. Why not issue a ton of long dated paper at these minuscule rates and then invest in productive infrastructure? Build out internet fiber to everyone’s home. If your country’s roads are bad - upgrade them. Same deal with airports and other transportation systems. Or how about converting your energy grid over to green technology?
But instead of stepping up the plate, too many governments are refusing to write the cheques. Then the massive over indebtedness causes a balance sheet recession. Which is followed by Central Banks trying to offset this slowdown with even more monetary easing, which only causes even more distortions.
One of these days…
The Central Banks are getting scared. It is becoming increasingly difficult to prop up economies with QE fueled equity rallies. That is why we are seeing moves towards negative rates. They are getting desperate.
The Central Banks are also becoming increasingly distrustful of each other. As world economic growth slows, the temptation to engage in competitive devaluations becomes greater and greater.
Have you ever noticed how when traffic is running smoothly people are generally friendly, letting other drivers into their lane? But when traffic clogs up all of sudden everyone turns into a fierce lane protecting mama bear? Same deal with Central Banks and governments. When the world is growing and the debts can be serviced, everyone is diplomatic. Yet the moment there is not enough to go around, the ugly side of human survival rises to the top.
Like it or not, this is the situation we currently find ourselves in. World growth is collapsing and governments are scared. They might find ways to justify their actions, but make no mistake - they are all trying to competitively devalue (except for the United States as they are not yet scared - but they will be soon enough).
Japan’s move to negative rates was nothing more than a cloaked attempt to devalue. The fact it had the opposite effect should set off the alarm bells. Do you really think Kuroda will look at the Japanese Yen reaction and conclude the market knows more than him? The more likely scenario is Kuroda will figure he didn’t go negative enough. Or that he needs to do even more QE.
What Kuroda should really be doing is buying gold
Right now many developed nations are easing policy by monetizing financial assets and moving rates to negative levels. But a few are taking a different road.
Have a look at this chart of the combined gold holdings of China and Russia over the past fifteen years:
Meanwhile, Japan’s gold holdings haven’t budged in three decades.
What is especially interesting is that gold priced in Yen has been in a monster bull move for the past two decades.
Eventually when the faith in financial assets is completely lost, the Bank of Japan will come for the gold. They will probably mark the top in doing so. But that is the end game for all these Central Bankers. They need to monetize against something to create inflation. Gold is the perfect asset - not foreign equities or the other junk the BoJ is buying.
It would be better if governments expanded on the fiscal side, but that is not in the cards, so the Central Banks will just keep easing. Eventually they will realize pegging gold at $3,000 or some other stupid high number will achieve what they are looking for. Some of the smarter Central Banks have already sniffed this out.
As for us, the mistake will be in selling your gold too early. Hang on. Make the sale to the Bank of Japan at the top…
Thanks for reading,