Everybody Has A Plan

Before we go into medias res, here is our usual, quasi-mandatory disclaimer on the whole thing, one that will undoubtedly be familiar to regular readers, but we repeat it always for the benefit of those who may have just stumbled upon this site:

We do not believe there should even be such a thing as a banking cartel with a central bank at its center, possessing nigh unlimited money creation power. We don't even think the State should be involved in the business of money production at all. There should be free banking, and what is used by the market as money and in what quantity  should be up to the free market itself.


Having gotten this objection to the monetary system as it is unfortunately constituted today out of the way, we are still left with the fact that things are what they are. Within this framework as it exists today, it is still possible for the individuals in charge of policy to embark on more or less prudent paths thereof.

We are extremely reluctant to present anything that looks even vaguely like a 'plan', because it is simply not possible to 'plan' the economy, or even just a certain extremely important aspect of it, such as money. However, a plethora of economists and analysts is doing just that, regaling the BoJ in print with their 'better' plans, this is to say, allegedly better than what the BoJ itself has implemented up to this point.

What it all boils down to – and this shouldn't be too great a surprise – is that the vast majority of these would-be planners urge the BoJ to 'grasp the opportunity' mother nature has served up in the form of a devastating earthquake and tsunami to finally 'inflate properly'.

One such jeremiad directed at the BoJ was recently reprinted at the FT's Alphaville blog, entitled “The Bank of Japan’s big chance”. Given that the FT as a whole is editorially steeped in Keynesianism and crude inflationism up to its proverbial eyebrows, we knew what to expect right after reading the title.

Below we want to offer a critique of the screed penned by BoA/Merrill Lynch's analyst Bin Gao, not because we want to pick on the man, but because  his opinion on the matter is broadly representative of the mainstream view, a view that is unthinkingly repeated across the breadth of today's financial press – much of which officially declares itself supportive of free market capitalism, but in reality stand for what we would term State Capitalism, i.e. the system as it exists today. It unfortunately retains only vestiges of the free market.


Bellyaching About Deflation

As everybody probably knows by now, in the wake of the earthquake, the BoJ has decided to – presumably temporarily – flood the Japanese banking system with a veritable torrent of money, which it has diligently created out of thin air. We have previously noted that the BoJ has actually pursued a surprisingly conservative policy in recent years, for a number of reasons (among these we have listed Japan's post-war brush with hyperinflation that still informs the country's 'institutional memory', as well as the utter failure of previous attempts to get the economy moving with the help of 'quantitative easing', or money printing as it is more colloquially known).

In spite of its conservatism in recent years, the BoJ surely felt it needed to be seen to 'do something' in the wake of the disaster. Specifically – we are only guessing here, but it is an informed guess – following such an enormous catastrophe, the demand for money proper was likely expected to be rising sharply.

After all, the 100ds of thousands of people who suddenly find themselves homeless and in the most dire circumstances still possess their claims on the banks they are banking with. Given their current distress it would be reasonable to expect them to withdraw money from heir accounts in larger amounts than they normally would (it is common sense; just imagine yourself in their shoes). In fact, it appears that Japan's largest bank has had trouble coping with withdrawals, which have overloaded its technological and back-office capabilities. Consider what this means for a fractionally reserved banking system. If an uncommonly large amount of money substitutes, i.e., deposit money, is withdrawn by depositors in the form of banknotes that then circulate outside of the banking system, the 'reverse multiplier' effect  sets in. If a bank were 'fully loaned up' to the extent allowed by the current reserve requirements, it would, ceteris paribus, be forced to contract its outstanding credit, which isn't so easy to do in a hurry. After all, the claims of depositors are immediately payable – whereas the bank's loan assets as a rule are not.

In the most extreme case, a bank could quickly find itself insolvent. At the very least, the credit creation process as it is now practiced would slow down or grind to a halt.

The BoJ surely reasons that it is within its remit to forestall such a situation. In a fully reserved banking system such a problem could of course never arise, but the system anything but fully reserved. Ergo, the central bank springs into action, using its 'flexible currency' to provide whatever amounts it guesses  will be required. Very likely the BoJ also holds that this is just a temporary measure that will be taken back again once the situation has normalized and the demand for money proper has fallen to its previous level.

Clearly, this can not possibly be enough for the inflationists infesting academe, the media and the analyst community today.

It is widely held in these circles that Japan has been experiencing 'deflation' for many years. As we have repeatedly pointed out, this is not the case. Japan's true money supply (money proper plus all perfect money substitutes) has been growing very slowly, but it has been growing. Deflation would only obtain if it were decreasing.

Consumer prices in Japan have been very gently declining over several years, which reflects the fact that slow money supply growth has been outpaced by a concomitant increase in economic productivity. It should be mentioned here that at the starting point of this 'deflationary era', i.e., the period of gently falling prices, prices in Japan were astonishingly high compared to prices in most other countries – an effect of the strongly inflationary bubble period that preceded the era of falling prices. As a glaring example proving this out, as of 2010, Tokyo was still the most expensive city to live in on the whole planet. If anything, one would have to conclude that prices should fall further.

Below are a few examples of prices in Tokyo in 2010:


FOOD: Lunch at a restaurant: $18*

Can of beer from grocer: $3.37*

One kg of rice: $8.47*

One dozen eggs: $3.78*

ENTERTAINMENT: Movie ticket: $22*

APPLIANCES: Washing machine: $879*

The strength of the yen has brought Tokyo back to the No. 1 spot on ECA International’s ranking for the first time since 2005. In addition to the costs above, rent for a two-bedroom apartment for expats is typically more than $5,000 per month in Tokyo, according to data from EuroCost International. While visitors need more pocket money here than in any other city, the monthly consumer price index in Tokyo’s wards has actually dropped year-on-year for 14 straight months as of May 2010, based on figures from Japan’s statistics bureau.


A two-bedroom apartment in Tokyo costs $ 5,000 per month to rent? How on earth can anyone be worried about 'deflation' in Japan?


Inflation Proposed As the 'Solution' – But No-one Seems to Know Why

This brings us to the above mentioned missive penned by Bin Gao. We will intersperse our comments. He writes:


“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.”


The entire premise is wrong. Why is 'deflation' (and remember here, there actually is no deflation in Japan, since the money supply kept increasing throughout the years of ever-so-slightly falling prices) allegedly a 'problem'? Falling prices for goods and services are the natural state of affairs for the market economy. As productivity increases, consumer prices fall. Since we do have one industry branch the productivity increases of which easily eclipse the growth in money supply all around the world (namely the computer industry and a host of industries related to it, such as e.g. telecommunications), even empirical evidence clearly shows that there's absolutely nothing wrong with falling prices. For producers, what counts is not the absolute price level of their final products – it is their price relative to the prices of the factors of production required to produce them. Evidently, the computer industry is a thriving, vibrant industry. The fact that the prices of its products have been falling from the day it was conceived has been an unalloyed boon for everybody in the economy.

The  rising external value of Japan's currency is not – repeat, not – 'furthering deflation'. Inflation and deflation both describe merely the increase or decrease in the stock of money outstanding. This is entirely independent of the external value of the currency, which in turn depends in the long run mostly on how quickly the Japanese money supply is rising relative to the money supply elsewhere. In short, Gao is putting the cart before the horse here. The reason why the yen has been so strong is that Japan's money supply growth has been far lower than money supply growth in the US,  the euro area and a host of other economies. The strong currency means that Japan  pays less for the raw materials it must import – and given that the country is extremely poor in natural resources, this is a strong positive. Meanwhile, in spite of the strong yen, Japan continues to produce a large trade surplus month after month and year after year.

We agree that a shrinking population is not stopping the central bank from inflating the money supply. We're not quite sure why this is even mentioned.

Having 'established' without a single word of explanation that more inflation would somehow be 'good' for Japan, Gao informs us that monetizing the government's debt would be the 'wrong way to devalue the currency'. This implies that there is a 'right way' of doing so, which is neatly skirting the fact that absolutely no-one has ever become richer by devaluing their currency. It seems to us this simple fact should completely obviate the need to think about the allegedly 'right' or 'wrong' ways of doing so.

Gao continues:


“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.”


A weaker yen is actually not 'surely in Japan's interest'. As a graying society in decline, it needs a weaker currency about as urgently as a hole in the head. What on earth should be good about increasing 'imported inflation' (i.e. making imports more expensive)? Japan has wisely avoided at least a part of the 'consumer tax' that rising commodity prices represent. In some developing nations these rising commodity prices have already led to uprisings and revolutions. While nothing of the sort is likely to ever happen in Japan, it remains utterly mysterious why burdening  consumers additionally with rising prices  should be regarded as a positive event.

It is to be strongly hoped that the BoJ decides to pass on this so-called 'opportunity' for the sake of Japan's citizens. Those are already faced with dire problems, they surely don't need yet another one. What exactly is this idea of 'importing inflation' supposed to achieve? Gao doesn't say.

There is not even a need for 'cautious debate', as Japan's government maintains. Just don't do it!

Gao then shows us a chart that is in many respects quite scary – comparing the size of the balance sheets of the Federal Reserve, the BoJ and the PBoC relative to the respective GDPs of their host nations. The 'scary' part is provided by the PBoC in this case, more on which follows further below.

In any event, the PBoC's incredibly bloated balance sheet is used by Gao as an excuse for why a similar blowing up of the BoJ's balance sheet need 'not be a concern'. The logic behind this argument escapes us completely. The fact that there is an even more profligate central bank just around the corner is a reason to emulate it? Why?



Central bank balance sheets as a percentage of GDP – China, Japan and the US. This vertigo-inducing picture is the result of a completely unanchored monetary system. The first thought that should come to mind is: how long before this house of cards collapses?



Says Gao:


“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!”


This a big  'so freaking what'?  Just because 'no-one seems to be too concerned' about the PBoC's obscenely bloated balance sheet doesn't mean no-one should be concerned. In early 2007, no-one seemed to have been too concerned about the mortgage credit bubble either, but they sure should have been. China's total money supply is nowadays greater than the US money supply, after growing in the region of 20-25% per annum for the past decade. The PBoC's balance sheet mirrors this incredible rate of money supply growth. It should be of the gravest concern to everybody, given the importance of China's economy to the world at large nowadays. How on earth does this constitute a valid argument for urging the BoJ to follow a similar path?



Of course, urging the BJ to inflate has been a favorite pastime of Keynesian economists in the West for many years. Ben Bernanke famously criticized the BoJ harshly in an infamous paper published in 1999. Calling for Japan to show 'Rooseveltian resolve' (as a reminder: Roosevelt presided over what is today known as the 'Great Depression'. Obviously his policies did not have the intended effect, or the period would be known by a different name), the paper contains the term 'aggregate demand' 17 times, variations on the term 'consumption' 9 times, and the term 'production' – you probably guessed it – exactly zero times.

We would recommend not taking this man's advice under any circumstances, even though it has been offered for free. This is clearly a case of 'you'll get what you pay for'. Luckily for Japan, the BoJ stopped listening around 2005.

Incidentally Bernanke is nowadays famous for getting just about everything about the economy wrong ahead of the 2008 crisis – see the famous video below, putting his quotes together (it would have been really difficult for him to get things any more wrong than he did. Anyone with even an ounce of common sense and no economic qualifications at all could have done better. Perhaps the next Fed chairman should be chosen by letting a monkey pick out someone from the phone book at random).





We Have a Plan Too

So what's our recommendation? That is quite simple. As long as there is a BoJ, best do nothing at all. If anything, look to raise your ridiculously low interest rates at the earliest opportunity instead of continuing to pretend that the cost of capital should be zero and that savers deserve no return. The best way of achieving this would be to announce that the BoJ will no longer set a target interest rate, but will instead allow all interest rates to be market determined from now on. This would be an excellent first step in phasing the central bank out.




1 China

We thought it opportune to make a few remarks regarding China as well, given the mind-boggling credit and money supply expansion in that country in recent years as mirrored by the size of the PBoC's balance sheet shown above. Here is a link to an excellent recent documentary on Australia's SBS Dateline on 'China's Ghost Cities'.

While everybody has surely heard about the infamous empty city Ordos by now, this short documentary manages to give us some fresh insights into the sheer scale of the problem and is well worth watching. Gillem Tulloch, who has previously penned an excellent report on China's crazy building boom is interviewed in the documentary and opines:

'What China is doing is akin to Pyramid building – it certainly 'grows GDP', but it does nothing to better peoples' lives'.

We couldn't agree more – in all likelihood, this is the biggest case of malinvestment in all of history. In fact, one could say that the Pyramids at least provide us with valuable 'monument services' nowadays, even though they have arrived with a slight delay of about 3,000 years. Egypt can thank these buildings for having created a belated tourism boom. It seems rather doubtful that China's empty and overpriced apartment blocs will ever be able to achieve anything similar.

We would also note, the idea that there is 'very little leverage' is probably incorrect. We believe the leverage may be hidden, that the rules are simply contravened by obtaining it surreptitiously in many cases. Also, there is surely an immense amount of leverage at the local government and developer level. China's government has the power to increase bank lending at will – it can always order the banks to lend money, whether it makes sense or not. This has so far delayed a bust, but it will ultimately not avert it. At present, China is attempting to brake the boom by increasing required bank reserves and slowly raising interest rates (which do however remain negative, i.e., deposit rates are still far below the increases in the consumer price index). It is hoped that this will achieve a so-called 'soft landing'. We are very doubtful on this account. Such an enormous malinvestment based boom in the context of an extremely extended period of capital mispricing can not possibly end well. Either the credit expansion continues to accelerate (which would eventually end with the destruction of the currency) or it is abandoned voluntarily, which will inevitable lead to a large bust. There seems no longer a third way out.


2 Japan

Apparently the problems at the Fukushima Daiichi plant are still not under control. Now reactor unit 3, which contains the dangerous MOX fuel, is once again making problems. More images here.






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4 Responses to “What Should the Bank of Japan Do Now?”

  • Money created by the central bank either becomes an immediate liability of the other banks or a different form of asset. In cases like this, I believe the primary purpose is to supply incompetents who can’t honor their liabilities with the species to write more bad checks and commit more fraud.

    Ben Bernanke is the biggest fraud ever put on the people of the US. Greenspan talked circles so sound like he was intelligent, mainly to cover up he didn’t have a clue what was going on. Bernanke on the other hand, has been promoted as an expert on what happened in the great depression. What he believes would have solved the depression is the very actions that caused it. His solution of blowing a bigger bubble is about as insane as shooting oneself in the head because the last shot wasn’t fatal. This is only a good idea if one is hellbent on suicide. Needless to say, every time I see this SOB on TV, my blood pressure goes up.

    Speaking of seeing this jackass, I was watching one of his last lying sessions to Congress. My youngest sister was at the house and I remarked Bernanke didn’t know any more about what caused the Great Depression than she did. It upset her I was calling her stupid. This falls right in with the plan to use monkeys to pick the next guy. They couldn’t do any worse than someone who watched Japan use the same technique to destroy their own economy. I noted there was another clip with Peter Schiff calling Bernanke a liar. Well he is either a liar or incompetent and believes his own nonsense.

    • He makes me cringe every time too. On the other hand, he provides me with plenty of material to write about. His alleged expertise on the Great Depression is in reality merely confirming his status as the world’s foremost monetary crank. It is obvious he never read Rothbard’s ‘AGD’. As to whether he is just lying or really believes his own BS, i fear it is actually the latter.

    • RedQueenRace:

      “Greenspan talked circles so sound like he was intelligent, mainly to cover up he didn’t have a clue what was going on.”

      I see Greenspan differently. With his Austrian/Randian background I find it hard to believe he did not know what was happening. I think it’s more a case of him becoming a politically pliant “economist” and central banker in his later years. He may never have uttered “coup de whiskey” in public or private but I feel he had to know what ultimately was going to happen.

      His post-Fed behavior reinforces this belief. He has been remarkably candid and open about problems in many cases as long as the politicians and masses cannot easily/definitively connect the development of those problems with his previous actions.

  • Bearster:

    Wow, I knew China had created a lot of inflation and malinvestment, but the scale of it is beyond what I had imagined. That graph of the balance sheets of the respective central banks is worth 1,000 blog entries!

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