Wake Up Central Bankers, Japan Tricked Us All!

What ever happened to keeping things simple?

Look at the investment world today. Everyone is getting smarter.

More degrees, more experience.

They’re also trying to make money in much harder ways.

I’ve always had an affinity to the simple approach: buy stock when they’re cheap or wait until they get cheap.

It’s not a strategy that leads to immediate gains. But it tends to work out pretty well over time.

Maybe that’s the problem, though.

Investors, especially the ‘smart ones’ want immediate success. They want gains this quarter, this month.

And to get it, they’ve got to pull off the impossible.

They create complex predictive strategies to make fast money. And believe me they need every IQ point when building these strategies.

The latest ‘right now’ trade is to buy Aussie yield stocks.


Because head of the Aussie central bank, Philip Lowe said they could possibly cut interest rates.

Revealed: Three In-House Small-Cap Stocks the Experts are Watching in 2019. Download today.

The supply, not price is important

If an investing strategy has made it into the Australian Financial Review (AFR) I think we can safely assume it’s probably old news.

What is a rate cut going to achieve?’ asks IFM economist, Alex Joiner.

It might do something to stock prices immediately. Long-term however, I’m betting the effect will be zero.

It’ll probably do nothing for our economy on its own. But how can this be the case? We’re always told lower interest rates stimulate an economy.

Yet the facts don’t seem to agree.

Here’s a little something I whipped up in last Friday’s Money Morning

You’ve always been told lower interest rate stimulates growth and higher interest rates lead to lower growth.

But then why is there a positive relationship between economic growth and interest rates?

Money Morning

Source: Reconsidering Monetary Policy

[Click to open in a new window]

In the graphs above, economic growth (GDP) is the black lines, long-term interest rates (10-year bond rates) is the blue line.

We see the same pattern for short-term rates too.

What does this mean?

It means the age-old adage of interest rates spurring growth is not true. If anything the opposite is true. When growth falls or rises interest rates follow.

You might hear some people say central bankers’ decisions just have a lagging effect, meaning it takes time for lower or higher interest rates to push growth back up or down.

‘“The data suggests overall that statistical causality runs from economic growth to long-term interest rates. Nominal GDP growth provides information on future interest rates better than interest rates inform us about future nominal GDP growth,” economist, Richard Werner wrote in his 2000 research paper.

‘“Our empirical findings reject the canonical view that interest rates somehow affect economic growth, and in an inverse manner. To the contrary, long-term and short-term interest rates follow the trend of nominal GDP, in the same direction, in all countries examined. This suggests that markets are not in equilibrium and the third factor driving GDP growth is a quantity.”’

But you don’t even need the empirical data to come to this conclusion.

Just look around you.

The Euro Zone, Japan, the US. Are these economies growing at breakneck speed? Is growth so uncontrollable thanks to long periods of low rates that central bankers are being forced to increase interest rates?

No? Why not?

I’ll tell you why. Because interest rates, the price of money, on its own does nothing to stimulate or retard an economy.

The key is money creation, not the price of money.

Surely Lowe has seen Japan waste away, even while interest rates remain negative?

Japan tricked us all

From the AFR:

Twenty years ago this month – back when the American economy was running hot under Federal Reserve chairman Alan Greenspan and the euro was making its debut on the world stage – the BOJ adopted zero interest rates, taking central banking into uncharted waters.

‘…Fast forward to 2019 and the Fed is normalising policy while the ECB is laying the groundwork to do the same. Despite moving first, the BOJ finds itself the outlier again, locked into an even more radical negative-rate regime and asset purchases of bonds, stocks and property trusts that dwarf anything attempted elsewhere.

Japan’s 20-year experience shows the limits of what central banks can do on their own and underscores the importance of broader economic reform and fiscal policy that dovetails with monetary programs.

The intellectuals over at the Bank of Japan know this. They know money creation, not interest rates stimulate an economy.

When Japan started on the road to negative interest rates, they knew it would do little to nothing without commercial banks creating more money.

The thing is, they didn’t want their economy to grow.

In fact, Japan wanted to punish the economy as much as possible. That’s because they wanted people, like the AFR author above, to believe structural change was the only way forward.

In his book, Princes of the Yen, economist Richard Werner argues that it was the American educated heads of the Bank of Japan that would try to force Japan to undertake structural change.

Benoit Leduc who summaries Werner’s book writes:

Princes of the Yen also argues that the Bank of Japan could have prevented Japan’s economic recession by lending money to corporations and banks from the beginning of the 1990s, but refused to accomplish this task because it considered a thorough reform of the banking system necessary.

The author argues that Japan did not have to liberalize and adopt market-oriented reforms in order to come out of its recession. All that was needed was credit rationing during the 1980s as a diet to avoid creating both bubbling land prices and an obese economy; and credit creation during the 1990s to provoke the growth of emerging technologies and the service economy.

All that was needed was to use the key control tool, credit creation, to supply the non-manufacturing and service sectors, especially high-value-added activities such as education, research and development, information services, software development, and telecommunications…with new purchasing power.

It’s strange that we’re seeing, much like fund managers, central bankers herd into the same idea. Because Japan has done it and others have followed, everyone else seems to think it’s OK to put bad ideas into practice.

If the RBA, the US Federal Reserve and the European Central Bank really wanted to solve their low growth problems, they’d start doing what Japan has known all along.

They’d demand banks start creating money in productive areas of the economy.

I’ll doubt we’ll see this anytime soon.

In the meantime, forget following the herd into yield stocks. Just keep things simple.

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: Our Three In-House Small-Cap Experts Have Revealed Their Top Picks for 2019. Download your free guide right here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia