Originally written on 16th May 2013
BoJ’s
ambitious plan to simulate domestic economy by sloshing the system with
monetary easing (printing yen and exchange these yen to buy bonds and mortgages
of all maturities) in order to stimulate domestic demand and inflation (2%
inflation in 2 years by expanding the monetary base by 2 times) will have
repercussion far beyond Japan
For
one, printing money to artificially sequester real interest rates will at some
point make investors in JGBs reluctant to either buy more JGBs or continue
holding existing ones in the portfolio-consider the plight of an investor who
has sacrificed consumption in the past to buy these bonds now find its claims
at par with those who have brought the bonds by simply printing the money!-That
scenario, if it comes to pass, will spell doomsday for Japan as the country
currently has the highest Debt to GDP ratio (>200%) in the world (to put it
in context, struggling Italy and Spain have debt to GDP ratio near about 100%
but unfortunately cannot print their way out of the problem) and public debt is
mainly financed through domestic savings.
After
the bursting of the real estate and stock market bubble in early 1990s’
Japanese retail investors have mainly preferred to invest savings in bank
deposits which in turn are channelized to buying JGBs. Loosing investor
confidence may result in steep rise in yields –no matter how much more the
government keeps printing money. On the other hand, retail investors were
comfortable buying JGBs near zero return given that inflation was negative in
Japan for a very long time and stagnant economy subdued outlook for other asset
classes (such as domestic real estate and equities), that may now change with
inflation outlook becoming positive and Nikkei at 5 year high giving investor
more options than putting money in boring JGBs
The
aggressive stimulus may have unexpected impact on Japan something with which
the world has no prior experience in recent history, If I were to make a wild
guess, I suspect the impact will be mainly on driving up steeply Yen yield
curve (the trick is plain to see for JGB investors) and the associated problem
Japan may face to funds its unbridled public debt –a scenario which will see
yen depreciating much more
What would
this mean for global asset classes
1. First and
foremost, selling one currency to buy another one eroding its value at a slower
pace is not a solution, the ultimate hedge will remain hard assets such as real
estate, commodities and metals
2. Secondly, even
though global economic growth may be sluggish, equities are placed relatively
better than bonds fundamentally, as they are natural hedge against
hyperinflation, as well as, share any upside that monetary stimulus is
purportedly suppose to achieve. In that case, equity valuation multiple may
remain higher than can been the case in recent past even without encouraging
topline or bottomline growth
3. Gold price
correction in the recent past is puzzling when juxtaposed with the debasing of
currency in Japan / US and maybe soon in EU due to competitive pressures. Gold
has always and will remain a hedge against monetary debasing and threat of
future inflation
4. As lower yen
conquers market share at Germany’s expense, EUs incentive to debase euro
further which will meet the interest of both northern and southern members will
rise, the question is if all three major currency blocs (EU, Japan and US)
desire a lower exchange rate for itself, the depreciation will be
relative to which currency?
5. An event /
catalyst which can trigger market to reject buying QE prone currencies and
nominal bonds denominated in those currencies will be a milestone event for
world monetary policy. And possibility of countries once again reverting to
fixed exchange rates or exchange rates tied to gold reserves cannot be ruled
out in next decade or so. Although this may sound far-fetched now, such
arrangements and reversion from free floating to fixed exchange rates and vice versa
have happened multiple times over the past 200 years. With each episode of
reversion from floating to fixed exchange rates being subsequent to sharp
episodes of inflation usually after rising wartime public debt
6. That view also explains
why holding gold as long as printing presses at major central banks keep
humming (and a few years after that to confirm status on ensuing inflation) is
a good idea even though there may be opportunity costs involved here.
7. Also for the
first time in a generation, equities might actually be a safer assets than the
risk-free asset called government bonds we grew up learning about
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