Guest Post: From Shirakawa To Kuroda: The Regime Change Explained

Tyler Durden's picture

Submitted by Martin Sibileau of A View From The Trenches blog,

The main take away from events in Japan is that the BOJ shifted from a tactic of interventions (under former Governor Masaaki Shirakawa) to one of monetary policy (under current Governor Haruhiko Kuroda) . What strikes us is that the monetary policy is precisely to... well, destroy their money and in the process any chance of having a monetary policy.

How the Shirakawa intervention worked

In Japan, the FX intervention is carried out by the Ministry of Finance, rather than the Bank of Japan. In order to sell Yen to the FX market to devalue, under Shirakawa, the Ministry of Finance issued Finance Bills, which were “bought” by the Bank of Japan, in Yen. Let’s call these first issues Finance Bills “1” and Yen “1”, which were issued by the Ministry of Finance and the Bank of Japan, respectively, as shown in the graph below (step 1). The Ministry of Finance was issuing “on credit”, because the issuance was going to later be repaid with funds obtained from the market:

April 21 2013 3

Next, with the Yen1, the Ministry of Japan bought USDs in the FX market (step 2). The price of Yen in terms of USDs dropped as its supply increased.  At this point, the amount of Yen circulating in the market was higher than before this intervention took place. This increase in supply is the amount I call Yen1.

To bring the supply of Yen back to the original amount in circulation, the Ministry of Finance issued Finance bills in the market. I will call this issuance Finance Bills 2, which are shown below (step 3). The amount of Finance Bills 2 equaled that of the first issuance, Finance Bills 1, and raises Yen2, so that Yen1=Yen2:

April 21 2013 4

Of course, as the Ministry of Finance went to the market to place Finance Bills 2, with this new issuance, the supply of government debt in Yen increased. As in any other bond market, as supply grew, yields tended to rise (i.e. price tended to fall), to encourage market participants to buy the increased supply.

Once the amount Yen2 was in the balance sheet of the Ministry of Finance, the Ministry used it to repay its outstanding debt with the Bank of Japan, which I called Finance Bills 1. Therefore, once this payment was done (with a lag), the balance sheet of the Bank of Japan remained unchanged and Yen1 were taken out of circulation. The Ministry of Finance had US dollars on the asset side of its balance sheet, matched by Finance Bills 2 on the liabilities side, as shown in the graph below (step 4):

April 21 2013 5

The graphs above show the balance sheets of all the participants in this intervention: The Ministry of Finance, the Bank of Japan, the FX market and the Yen Government debt market. But it is also be interesting to show the intervention in terms of cash flows. In the graph below, we can see that de facto, the Ministry of Finance ended up as intermediary between the Government debt market and the FX market. In essence, the intervention “moved” Yen from the Government debt market to the FX market, and this was a “fragile” movement, because it was simple arbitrage.

Whenever an asset has two different prices, arbitrage arises and fixes the “anomaly”. You may wonder why I imply that the Yen had two different prices. I want answer with another question: Why would the JGB market need a “middle-man” (see graph below) to provide Yen to the FX market? It didn’t!

April 21 2013 6

The JGB market was “not willing” to buy US dollars (i.e. provide Yen) from the FX market at a loss (i.e. buying US dollars at above market prices). Who ended up taking the loss? Who ended up buying US dollars at above 80-82 Yen per dollar? The Ministry of Finance did, which meant the average Japanese tax payer! The Japanese taxpayer subsidized the big exporting conglomerates of Japan, so that these would provide “financing” to the American consumer who remains broke. The subsidy was significant because as we saw in the graphs above, two things take place simultaneously: a) Interest rates in Yen would tend to increase (i.e. price of Yen Finance Bills will tend to fall) and b) the holders of Yen (i.e. Japanese consumer) lost purchasing power. Given the demand for JGBs, the temporary nature of the interventions (which did not shape inflation expectations) and the short-term of the debt purchased, the marginal effect of issuing Finance bills 2 was not relevant (i.e. on interest rates).

In the long term, with these interventions, the Ministry of Finance had P&L risk (i.e. the risk of having a loss, if the USD depreciates further) which could only be addressed with higher debt (i.e. higher interest rates) or higher taxes. Under intervention, the Profit/Loss position of the Ministry of Finance was determined by:

P&L = D US dollars (in its Assets) / D t – D Finance Bills 2 / D t

Whenever the Fed undertook quantitative easing and the value of the US dollar fell, it generated a negative mark-to-market to the Ministry of Finance’s position (if they indeed mark themselves to market).

How the Kuroda policy works

Under Mr. Kuroda’s leadership, the BOJ will not be manipulating interest rates (i.e. price), but will target the monetary base (i.e. volume). The problem is that he pretends to be in control of both, when the fact is that this ancient truth holds: One can only control price or volume, but not both simultaneously.

The new policy consists of:

1.- Increasing the monetary base at an annual speed of JPY60-70 trillion (stock of JPY200 trillion by Dec/13 and JPY 270 trillion by Dec/14).

2.- To accomplish No. 1, the BOJ will purchase approx. JPY7 trillion in JGBs/month, on a gross basis. On a net basis (i.e. net of repayments), holdings of JGBs will rise by JPY50 trillion/year.

3.- JGBs purchased will include long-term issues (incl. 40-year, previously limited to 3-year maturities), raising the average remaining tenor of the BOJ holdings from 3 to about 7 years.

4.- Achieving a 2% inflation level as soon as possible

5.-Purchases will include also ETFs and REITs (Japanese)

With the Shirakawa intervention the market had to assume that the devaluing efforts were temporary, or at least not within a specific time frame, and consistent with a policy of keeping interest rates at zero. Challenging the BOJ was a frustrating experience. Under Mr. Kuroda however (and here is where I disagree with mainstream analysis), Japan is entering the uncharted waters of a Latin American-style inflationary spiral (very similar to the plan implemented by the late Martinez de Hoz, also called “La Tablita”).

The chart below shows the balance sheets of the involved economic agents:

April 21 2013 7

As you can see, there is nothing fancy here. Given the magnitude of the monetary expansion, what is a big unknown is what will the net aggregate reallocation of JGB holdings be, outside the Ministry of Finance. Because the BOJ will not only buy issuance of the Ministry of Finance, but also existing stock of JGBs. For now, it is all speculation and the flows are monitored closely. The reader will find plenty of research material on where Japanese banks, pensions, insurers and households will reallocate the JGBs that they sell (if they sell them). I think they are and will be exponentially selling them, because the pace of the devaluation in the Yen will generate tangible profits to those doing so.

When one owns a fixed income asset with a negative interest rate, it is difficult to grasp that purchasing power is being destroyed. The asset is benchmarked against an arbitrary consumer price index. If at the same time there is a certain, known rate of devaluation in the currency of denomination of that asset, there is still difficulty in assessing whether if, in terms of other goods in the same currency (but not in terms of imports), value is being destroyed.

However, there is no doubt that under a known rate of devaluation, if that fixed income asset is swapped for another one denominated in the appreciating currency, there will be a profit. In the case of Kuroda’s policy, because the devaluation is not a one-and-for-all event but a certain, over-no-less-than-2-years process, the devaluation of the yen morphs into a “rate” of appreciation of foreign assets and prices of imported goods.

This rate of appreciation is therefore fungible into another magnitude: Yen-denominated yields. Therefore, a circularity ensues: Yen-denominated yields/spreads will incorporate devaluation expectations. As yields/spreads rise, the Bank of Japan will be forced to buy more JGBs, to keep yields within a level that it deems tolerable. As the BOJ buys more JGBs, the devaluation will likely accelerate.

It is important to understand that this circular, spiraling process can take place regardless of the RELATIVE reallocations done by the Japanese banks, pensions, insurers and households. What matters is that as more Yen is printed, more Yen is available and it devalues vs. the USD. The speed of devaluation will indeed be influenced by the relative reallocations above.

April 21 2013 8

Additional observations on volatility and growth

Kuroda’s policy has and will continue to generate enormous volatility in the JGB market. That same volatility was likely a factor enhancing the effects of the manipulation in gold.

With regards to volatility in JGBs, I found interesting a suggestion made by Shuichi Ohsaki and Shogo Fujita, from Bank of America’s Pac Rim Rates Research team, dated April 11th. According to the authors, the volatility could be diminished if the BOJ announced a schedule for buying operations, with the amounts that would be purchased in each maturity sector. In other words, it would help if the BOJ would improve its communications strategy. What I find of interest in this suggestion is that it is contrary to an increasing common belief regarding exit strategies available to the Fed. Indeed, when it comes to assessing the possible impact of balance sheet management by the Fed, analysts advise that we look at its US Treasury holdings in terms of 10-year duration equivalents. The actual distribution of maturities in the Fed’s holding is perhaps not so relevant. Ironically, this wisdom also comes from the Bank of America, although from a different team (i.e. Brian Smedley, Global Economics Rates & FX, “The consequences of a “no sales” Fed exit strategy”, April 10th, 2013), as well as from BMO Capital Markets (Dimitri Delis, March 25th, 2013). Personally, I side with the view of Ohsaki and Fujita: To me, distribution matters as much to the BOJ as it will to the Fed.

With regards to the impact on real growth of the Kuroda’s policy, I cannot mince words: It will be disastrous. Whenever the medium of indirect exchange of a nation is destroyed, no growth can ever be expected. The coordination process needed to allocate resources is seriously impaired. And to explicitly have the central bank tell their people that the monetary base will be doubled within two years is nothing short of destroying their medium of indirect exchange.

For some reason (unknown to me), Robert Feldman (Morgan Stanley, April 4th and April 17th, 2013) is more optimistic. He believes that Japan still has a chance, if the country implements what he refers to a “third arrow” policy. Feldman’s third arrow policy is a list of actions that would promote growth, in agriculture, medical care, energy, employment and electoral system... I wonder whether Mr. Feldman seriously asked himself why any initiative in these fields would require that the monetary base of the country be doubled by the end of 2014…


With the interventions under Shirakawa, the Bank of Japan did not need to sterilize, as it is clear from the mechanism previously described. The BOJ’s balance sheet remained unchanged at the end of the intervention. This supposedly meant that the BOJ was independent.  However, given the resulting long USD risk position by the Ministry of Finance (see step 4 above), in the long term, coordination with the Fed would have been required. In my view, it was exactly because the Fed’s (undisclosed) intention was to engage in never ending Quantitative Easing, that Japan was forced to implement the policy undertaken by Kuroda. Coordination with the Fed was impossible.

With Mr. Kuroda’s policy, we now have the BOJ with a balance sheet objective, the Fed with a labour market objective (or so they want us to believe), the European Central Bank with a financial system stability objective (or a Target 2 balance objective) and the People’s Bank of China (and the Bank of Canada) with soft-landing objective. It is clear that any global coordination in monetary policy is completely unfeasible. The only thing central banks are left to coordinate is the suppression of gold.

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JustObserving's picture

Achieving a 2% inflation level as soon as possible

McDonalds Japan has that target beat by 1000%

Precious's picture

I'm sure by now most people know that Japan takes orders from America. That's the entire plan.  USA didn't drop nukes for nothing. Japan was on the short list before WWII was even instigated. Before Pearl Harbor was even contemplated. The West was in search of any reason to put the East squarely under its thumb. Only Japan refused to lie down. The rest like China were a cakewalk. Japan is the land of political zombies. The sheeples are never taught a thing about politics. Otherwise they would know they are the 51st state of the USA. The chart goes like this: [ ¥ --> $ ]

jbvtme's picture

sony=standard oil of new york

Manthong's picture

so very sad what is being done to them.

DoChenRollingBearing's picture

Japan's bearing companies are not under the US thumb!  They are taking names and kicking ass vs USA's Timken.  We now buy from a (small) bearing manufacturer there.

But, we buy more from Korea, and yes, China.

Peru would be a reasonably gauge for the world bearing markets in general, at least among countries who do not manufacture bearings.  And Japan is doing just fine in those countries.  Devaluation will help their sales, at least in the short-term.  The wholesale damage (to Japan's economy as a whole) of a lower Yen will come later.

Motorhead's picture

Gotta love that drum intro by John Bonham.

A Lunatic's picture

Every "fix" relies upon the fantasy of perpetual growth in a world of peak everything.........

HulkHogan's picture

Alchemy would fix that. /s

Benjamin Glutton's picture

well then...since they all adopted my suggestions regarding coordination and suppression do I get to be a Nobel Laureate like PK and Hobama?

CheapBastard's picture

Market forces eventually win. Ask Nixon and the results he got with his price controls.

williambanzai7's picture

The efficient market hypothesis says bullish on ink.

Arrowflinger's picture

Data-processed debt is in red electrons?

Zzzztttttt...and it's GONE!


ISEEIT's picture

Don't get greedy. Purely an opinion (obviously) but I see USD/JPY hitting 92 a few times just for fun on the way to paradise.

Mine Is Bigger's picture

Totally unrelated, but Mt. Gox seems to be down again.

phyregold's picture

I'm telling you and i'll lay it out again.  I've been saying this takedown of gold is orchestraded as suckers bets.  They are going to do it again and again and evaporate liquid assests!

Everyman's picture

IF they orchestrate another gold beatdown somebody on Wall Street is going to start kiling other assholes on Wall Street.  They can't do that again, the damage and evaporated "asset values" of paper PMs alone was en ough to get tounges waggling on Wall Street.

I hope they try t again, that is when the WHOLE THING BLOWS UP!

ISEEIT's picture

How many times is a guy gunna get jacked for $130,000 in a clear raid before going all "f it" on 'em? I'm cool because it was all 'free money anyhow'.

What about the fools trying to live on this though?

Keeping my warehouse job-:)

gwar5's picture

This article is like the comments out of my own fingers earlier (only this is way better) from the Bernanke Jackson Hole article couple of hours ago. I wondered if anybody but me thought the banking cartel was fracturing and just focusing on trying to save themselves.


If all true, it means fighting retreats by wounded animals (bankers, governments) trying to survive. Means bankers and government in-fighting more, too. 

Regarding the singular coordination in the suppression of price of gold -- would also seem to mean the price of gold is now fully weaponized. Pre-emptive targeting and counter measures must have already been put in place by rival central banks. 

If the price of gold can be used to destroy other unfriendly central banks staggering around, it can be used for leverage and major concessions. Regardless, there has got to be much fear and loathing out there we are not seeing. Probably is what has the Fed and Troika so 'spooked' lately. They don't have the gold to play at the no limit table.

How do we know Cyprus was not really a China idea after they hauled out 800 tonnes since the first of the year threatening the LBMA? The IMF is a branch of the UN.


Q: Bankers and politicians, standing at the abyss... who gets pushed in first?  

A: Who cares?


StychoKiller's picture

The arrogance!  The unmitigated hubris!  Economies/Markets are nth-variable, multi-dimensional, and NON-LINEAR differential equations.  Squash a bump over here, fill a void over there, but there's no way to predict when or where the multi-dimensional fabric is gonna rip wide open, revealing the infinite abyss below!

ArkansasAngie's picture

Deflation is not what they intended with gold. Keep buying physical and bernanke will get what is coming to him ... along with JPM et al
Naked shorts?

Cacete de Ouro's picture

Is anyone listening to me?

Yen Cross's picture

    The usd/jpy looks like it might make a run for the 100 barrier today. Currently trading on the 99.81 handle.

 Here's live quotes.

Whiner's picture

If I want to buy a commodity with my printed dollars, why not pound it down good beforehand, then buy. Rinse repeat. Added benefit: keeps sheeple in fiat denominated assets which I am jacking sky high with QE to damoon! But Chavez and Germany made it clear I needs to accumulate my own AU on the sly as my own hedge, cuz I done lease-hypothecated most all my once and future real currency. All this can work perpetually, no? But some wiser sheeple just woke up, and bought AU on a 30 year record smack down. PM sales up 67% YoY. Is it game over? PM Horse out of the paper barn? Phyz price running? Them ain't rising premiums, folks. Them is rising bullion prices.

StychoKiller's picture

Rising prices?  More like falling (in value) FRNs!

dunce's picture

Every one has different objectives and some are both internally and externally mutually exclusive. This will not end well.

donpaulo's picture

I reckon the Japanese will stay solvent one day longer than the folks who are shorting them are able to

matrix2012's picture

In the long term, with these interventions, the Ministry of Finance had P&L risk (i.e. the risk of having a loss, if the USD depreciates further) which could only be addressed with higher debt (i.e. higher interest rates) or higher taxes. Under intervention, the Profit/Loss position of the Ministry of Finance was determined by:

P&L = D US dollars (in its Assets) / D t – D Finance Bills 2 / D t


I'm at lost here, please someone explains whats the D and t in above equation:

P&L = Profit & Loss

D = ??? (depreciation?)

t = ??? (time/treasury/tax ???)