When Will the Inflationary Stock Boost End?

The news out of Japan gets stranger by the minute.

According to the Japan Times last Saturday the economic and fiscal policy minister Akira Amari said the government ‘will step up economic recovery efforts so that the benchmark Nikkei index jumps an additional 17 percent to 13,000 points by the end of March.’

Have you ever heard of a politician giving explicit targets for the stock market?

So now the Japanese government is doing two things. First, it’s leaning heavily on the Bank of Japan to print money aggressively, in order to incite inflation and lower their currency. Second, they’re now setting a precise target for the Japanese stock market

Japan Trashing the Yen

The fact is the rise in the Japanese stock market so far is a function of the falling Yen anyway. So what he’s really saying is that he wants to trash the Yen further.

The beauty parade of potential governors for the Bank of Japan is picking up pace and contenders know that they had better be in favour of more money printing or they don’t stand a chance.

Haruhiko Kuroda, who has thrown his hat into the ring for the job, has said that additional monetary easing can be justified this year. What a surprise.

The Yen continues to spiral down and the Nikkei continues to spike higher on the expectation of a surge in exports due to the weaker currency.

But let’s think about this for a second. Japanese conglomerates have been losing market share for years and I’m not sure the loss of market share is purely due to the strong currency. Therefore will a weaker currency translate into a surge in sales? I don’t think so.

Sony Corp is down from over $110 to $14 over the past 12 years. You can’t blame a fall like that on the currency alone. So I don’t think a further fall in the currency will stop the rot.

Why don’t we just stop the charade and get the central banks and governments to tell us what price they’d like the price of everything to be so we can all stop guessing.

Having watched markets for twenty years I can honestly say that I’ve never seen them so heavily manipulated. And the future holds more of the same.

I can’t imagine that we’ll see politicians announcing that they have been wrong all along and they would like to apologise for sticking their noses in where they didn’t belong.

The more they stuff things up, the more they’ll say that they need to do more to correct the mistakes (although of course they’ll blame those mistakes on forces outside of their control). They’ll keep doing that until the whole edifice tumbles down on their and our heads.

Japan’s economy is definitely the poster child in this respect so I have little doubt that the cracks will appear there first.

If they do convince everyone that inflation is coming to Japan after about 20 years of deflation do you think their long term bonds will stay below 2%?

Almost 25% of government revenue goes to paying interest on their debt with interest rates at multi-generational lows. What will happen to that figure if bond yields rise to 3% or 4%? It will be game over for Japan, that’s what.

Japan is trashing their currency to incite inflation and if they succeed they just might bring about their own downfall.

Demand for Money Down, Supply Up

Not to be outdone, the US Fed is playing catch up.

I watched a great presentation this week that focused on the relationship between the velocity of money and the current Quantitative Easing by the US Fed. You can find the presentation here if you’re interested.

The basic premise of the presentation is that the velocity of money (which is the average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time) has plummeted since the dot com crash in 2000. Accordingly, that is putting pressure on the Fed to print more money to keep the system stable.

M2 Velocity in the US



The money printing by the Fed isn’t translating into a surge in activity because the banks aren’t lending, due to their damaged balance sheets. And consumers and businesses aren’t borrowing, because they already have too much debt and there aren’t many opportunities to pursue.

So at the moment the Fed is basically pushing on a string by printing more money.

But the risk is if the velocity of money turns around and starts heading higher, then the inflationary response could be vicious.

In the past when the velocity of money picked up the Fed would start raising rates to counteract the inflationary consequences of a rising money supply and a rising velocity of money.

But now that the Federal government has such a huge debt burden it will be far harder for the Fed to raise rates and thus increase the interest payments owed by the government as a percentage of their revenue.

The Endgame Approaches

This is a dangerous set of circumstances. When inflation takes hold the Fed will drag its feet and we could go from very little inflation to immense inflation very quickly. In that situation the bond market would collapse anyway and force the Fed’s hand.

This may be a story for 2015 or beyond, and we’ll probably see a deflation in asset prices prior to the final act, but there is no doubt the ducks are all in a row for this outcome.

So Japan may be the first to implode, since they started their journey into the Keynesian sinkhole before everyone else, but the US Fed is determined not to be far behind.

So it’s quite clear that both the Bank of Japan and the US Fed are going to keep their foot on the gas for the foreseeable future. This could mean that the Aussie equity market will rally faster and further than most (including me) thought possible.

Our equity market is highly correlated to the Japanese Yen due to the effect of the carry trade, so if we continue to see a collapse in the Yen equities may continue to fly.

Murray Dawes
Editor, Slipstream Trader

Murray Dawes is the Editor of Pivot Trader and contributing Editor at Money Morning. He was one of five, from 5,000 applicants, chosen for a graduate position with the Swiss Banking Corporation — now part of banking giant UBS. The bosses quickly cottoned on to his potential and pushed him up the ranks as a futures broker on the floors of the Sydney Futures Exchange. Murray later broke out on his own, and developed custom trading systems to trade leveraged financial instruments like futures. Due to his success, Murray became the ‘hired gun’ trader for Australia’s rich and famous. Today, Murray runs a trading service through Port Phillip Publishing to help everyday Aussie investors use his advanced trading methods.

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