Is the Federal Reserve Using the Bank of Japan’s Playbook?

All the current talk is about the US Federal Reserve and the question of will-it or won’t-it taper. The Fed will answer that question this week.

Until then it’s worth looking at the central bank that has become the model for the US Federal Reserve, the Bank of Japan.

Japan’s all-out assault on deflation has taken global economic management to a new low. Japan’s central bank – at the behest of the government – plans to double its money supply (twice as much paper money in the system) over the next two years.

The aim of this ‘strategy’ or more correctly ‘stupidity’ is to try to generate a 2% inflation rate in order to head off deflation.

As a consumer I quite like deflation – it means goods and services become cheaper each year. Falling costs have been a major driver behind Japan being a nation of savers – why buy today when prices will be lower tomorrow?

Whether Japan will succeed in its stated aim is the subject of great debate…

However what isn’t in dispute is the impact the Bank of Japan (BoJ) announcement had on the Japanese share market, the Nikkei 225.


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Source: Bloomberg

Since the BoJ proudly declared its intentions on 4 April 2013 the Nikkei has risen around 20% in value.

The abundant supply of cheap money has become a plaything of the investment institutions (just like in the US) – so just how much actually reaches the real economy is yet to be seen. The only inflation the BoJ may end up generating is the inflation of a share market bubble.

Just what the world needs right now – another asset bubble.

How Global Forces Will Impact Australia

Japan is already the proud owner of one of the biggest bubbles in history – the highest debt/GDP ratio. The following chart from The Economist shows how the temptation to borrow at the lowest rates in history proved too much for successive Japanese governments.

Nearly 25% of Japan’s tax revenue is now committed to paying the interest on their Everest pile of debt. Imagine the budget chaos if interest rates merely drift back up to the 2% range?


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The following chart, also from The Economist, shows that all major economies have flat lining interest rates and the forecast is for them to remain this way.


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The reason for this is none of these countries can afford an increase in interest rates. The interest payments on their existing (and growing) public debt are consuming more and more of their tax revenues – and this is with interest rates at historically low levels.

Even a modest 1% rise in interest rates would add tens and even hundreds of billions of dollars to their interest servicing costs. Governments are already running massive budget deficits (with the lowest rates in history), so what hope would they have if interest rates rose? The term ‘buckleys and none’ comes to mind.

There has been some conjecture that Australian interest rates may have finished falling and the next move (according to some) will be for rates to rise.

The prospect of Australia raising interest rates against a global backdrop of ultra low rates is pretty slim. The other reason I suspect rates will go even lower in Australia is the comparative strength of our dollar. The recent fall from $1.05 to the low 90-cent range is not enough to restore our international competitiveness.

The recent news about a softening jobs market and a contributing cause being the high dollar is likely to bring a lot of political pressure on the Reserve Bank to wade into the forex market and force the Aussie dollar lower.

The Reserve Bank will have a battle on its hands. The currency war Japan has escalated means the major economies will actively try to debase their currencies in order to protect their export industries.

In my opinion the Aussie is destined to be swept aside when the unintended consequences of the global currency war, QE to infinity or one of the other central bank fixes causes markets to panic.

The rush of money to buy US Treasuries (for perceived safety) will greatly strengthen the US dollar. The Aussie in the 50-cent range within the next 2-3 years is a distinct possibility.

Not that the US is any great safe haven – it’s just that in times of panic it is the best looking horse in the glue factory.

Here’s Why You Shouldn’t Buy the US ‘Recovery’

 In spite of Bernanke’s herculean efforts with the printing press, the US economy is still a very sick puppy.


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The above chart is a combination of various US economic indicators. The large grey shaded area in 2008/09 is the GFC induced recession. Economic activity went into free fall during this period.

Post-GFC the resurgence in economic activity has been closely correlated with the Federal Reserve’s various stimulus efforts. In dollar terms and in duration, each stimulus effort has been greater than its predecessor. Yet the boost to economic activity is diminishing.

There is a point when excessive drug use is counterproductive, and this appears to be the case with the US economy.

Here are some interesting charts from on gasoline and petroleum usage in the US. You can identify the weaker trend in the past few years (post-GFC).

The first chart tracks the sales of Motor Gasoline (black line) and Petroleum Products – heating oil, propane and kerosene (red line).


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The red line is back to sales levels last seen in 1997.

The next chart shows daily Gasoline retail sales have fallen 50% since the GFC.


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Normally increased energy is one of the indicators of an economy in recovery mode. These trends suggest the underlying economy is weak and getting weaker.

This is how the analyst at summed up the data in these charts:

Perhaps, just perhaps, Occam’s razor (the principle of the simplest answer being correct) applies in this situation as well, and the collapse in energy demand in the US has little to do with MPG efficiency, higher productivity, and throughput mysteriously achieved just when the entire economy was imploding in the months after the Lehman failure, and despite the re-emerging proliferation of cheap Fed debt funded SUVs and small trucks … and everything to do with the US consumer being slowly but surely tapped out?

Of course, if that is the case, than the US economy is far, far weaker than even we could have surmised, although it certainly would explain the desperation with which the Fed is doing everything in its power to preserve the levitation of the S&P…

When the real state of affairs of the US and global economy can no longer be disguised by funny money and statistical trickery, then watch out below. Then the tables will be turned. Instead of rising share markets and falling interest rates, the reverse will happen.

As share markets plummet, it’s likely interest rates will rise as the bond market starts to price in the sovereign default risk it has ignored for so long.

This is the yin and yang of markets. Complacency and misplaced trust in the ability of central bankers has investors only focused on the former and not the considering the latter.

Vern Gowdie+

Chairman, Gowdie Family Wealth

Ed Note: Vern’s personal mission is to secure your family’s wealth over the challenging years ahead. To see the urgent action you need to take today, click here.

Vern has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

From the Port Phillip Publishing Library

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Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

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