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Thursday December 3, 2009 - 17:25:38 GMT
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Forex Blog - With Japan Staring into Deflation Abyss, Time for BOJ Intervention, QE (FXA)

With Japan Staring into Deflation Abyss, Time for BOJ Intervention, QE


What is extraordinary in recent weeks in Japan with deflation charging through Japanese streets like a giant angry flesh eating T-Rex is that Japan has not gone to its default position…sell yen, buy dollars and some euros. 


Frankly the only reason I can tell for why Japan’s new government has not started up the T-Rex disabler FX intervention machine is the new (DPJ) government’s campaign pledge to not use currency intervention even when the yen was rising in some wildly distorted effort to distinguish itself from the opposition (LDP).   I think I need to be Japanese to understand this…it should be clear from the last 5 ½ years that the LDP has refrained from currency intervention too despite periods of yen appreciation. 


But those campaign promises seem to be wearing thin. Today, assuming translations were accurate, Prime Minister Hatoyama declared the yen’s rise cannot be left as us (whether temporary or not). That sounds like the words of the mayor of the city where the marauding T-Rex is rearranging the landscape.  “Dem sounds like intervention words to me.”  But like a busy PA aide for US VP Biden, the cabinet spokesman Hirano ran to cover for the PM…Hatoyama was not commenting on Forex intervention, but instead was probably referring to the fact he is watching forex moves closely. 


Yet, Japan’s mixed messages on the yen and deflation don’t end here.  The BOJ emerged from hibernation in the midst of a winter of deflation Tuesday (flushed from its ice cave by no other than PM Hatoyama) and announced a new liquidity facility for adding reserves to the banking system (so they can park more money with the central bank and buy more JGBs).  Hatoyama welcomed the measures.  The chief bank regulator in the cabinet, Kamei, said he was deeply unhappy with the BOJ steps taken Tuesday and called the BOJ “sleepy headed.”  Kamei has a point. If the banking system is not creating credit, then a central bank needs to get funds into the system outside the banking system…QE or expanding its balance sheet like the Fed and BOE have done…buy securities directly from the market.   Moreover, the BOJ, under MOF instructions could kill two birds with one stone…add permanent reserves to the system and check the yen rise…by purchasing foreign assets from the market.  Former LSE Econ professor and BOE adviser Goodhart wrote in the FT this week that the yen and euro are strong unlike the pound and dollar (weak) because the BOJ and ECB have not expanded their balance sheets (engaged in QE or buying securities from the market directly) as the Fed and BOE have done since last fall. 


However, BOJ Governor Shirakawa this week said the BOJ does not have the legal authority to purchase foreign currency assets (Reuters) by expanding its balance sheet.  I saw little write up on this by the newswires or banks but this was a curious statement to say the least.  Why now? What for?  Was there government pressure or perhaps external pressure for the BOJ to start QE and the two-birds-with-one-stone policy of buying foreign currency assets directly (in the Bernanke playbook on non-traditional monetary policy)?  Or perhaps Shirakawa was indirectly asking for this authority? 


Today Dow Jones confirmed rumors in Asia overnight that MOF’s head of international bureau Tamaki met with his counterpart in US Treasury Lael Brainard (confirmed last week) earlier this week.  The rumor from Tokyo (less rumor and more fact) was that Tamaki was appealing to US Treasury to join Japan in coordinated currency intervention (sell yen and buy dollars).  Maybe Brainard showed Tamaki a live webcam shot from downtown Detroit or a chart of GM stock price or US auto sales.  I can’t imagine the US Treasury (and White House – Summers would weigh in on this) agreeing to currency intervention to help Japan’s export economy avert deflation.  Officials in Japan have already labeled the yen rise as abnormal.  I find it hard to call the pace of the yen rise as excessive.  If Japan wants a weaker currency, get the BOJ to launch quantitative easing…is probably the message from Washington to Japan on the strong yen. 


Perhaps Tamaki flew to London and Frankfurt (Ottawa?) upon leaving Washington to peddle his intervention message there.  I would bet all my toro Europe has little interest in reversing yen gains against the euro or pound. 


So here we are…unilateral intervention conditions are mostly in place in Japan.  First the government has called the move abnormal and excessive.  Second it has adjusted monetary policy providing a fundamental basis for making currency intervention more effective (in theory).  And it has reached out to its G7 (at very least G3) partners for help and understanding.   The only unknown issue is at what level the intervention war will start.  If Sakakibara is right we have to expect it on a sustained break under 85.00. 


If we assume as Goodhart argues, that the global financial system is in a liquidity trap (the banking system as a credit creation machine is dysfunctional) this requires central banks to go around the banking system and buy assets (expand balance sheets) directly from the market which has the effect of shifting portfolio allocations from lower risk assets to higher risk assets (the carry or correlation trade) and supporting asset securitization markets (shadow banking system) where credit creation can take place.  The sooner Japan and the Euro Zone come to terms with this reality, the sooner their currency problems will be resolved.  But consciously or subconsciously they prefer to free ride real policy stimulus from the Fed and BOE.


David Gilmore




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