Albert Edwards is not a fan of QE, but even he makes one exception. As he notes in his latest note "Going all in", Japan has no option "as it is
fiscally bust."
Edwards notes that QE works by driving up financial asset prices; but that, "in practice, seems to have had a limited effect in boosting the real economy ?aside from increasing inequality. Furthermore, the one (price) thing that QE does change and that does make an economic difference is that it enables a lower exchange rate ? but only to beggar thy neighbour."
Said another way, the reason why development nations find themselves mired in deflation is that despite all their "unconventional policies", they are unable to offset all the deflation exported to them by all the other central banks who are doing the same. As a result, at the end of the day, he who debases first, debases best.
This is evident in Japanese corporate profits, which since 2013 have boomed like never before and, as Edwards says, "Abe hopes and prays this will spill over and spark a positive wage/price spiral. Yet, in the absence of further Japanese QE, the yen has been paddling sideways against the dollar in a ¥125-118 range since last November ? and the yoy decline will soon drop away to zero. In fact, that is already the case on the BoE trade-weighted yen measure ? see chart below."
What caused this?
In my view, the year-on-year fall in the yen has been the main driver for yoy growth in profits, as well as the yoy rise in underlying consumer prices and wages, and indeed the yoy rise in GDP. One (aka Japanese authorities) needs to maintain that yoy decline in the yen to light the spark that might ignite (but has not yet) the wage/price spiral. It reminds me of kick-starting my old 1953 BSA M21 single cylinder 600c motorcycle (picture here). I had to use the valve lifter to move the piston to begin its downswing, otherwise the kick-start would snap back and break your ankle. But with skill and several bruises, eventually the beast would start. Similarly the yen is the kickstart that the BoJ needs to keep priming to eventually fire up the economy.
And yet, over the past few weeks we have seen Kuroda's unwillingness to plough on blindly with even more QE. Still, for the profit miracle to persist, Japan will have to debase its currency further. According to Edwards this means that the currency wars waged over the past 7 years will likely have to be taken to the next level. And to explain what that means Edwards looks at the infamous Ben Bernanke 2002 speech "Deflation: Making Sure "It" Doesn't Happen Here [16]" (or ?the helicopter money speech? as it has now become known).
Explaining how the Fed had ample QE tools to make sure that the US did not end up like Japan, towards the end of his speech, Bernanke went on to outline what the Fed could do if aggressive pursuit of QE began to drain liquidity out of the bond markets (ie running out of domestic assets to buy just like Japan is now).
"?The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.?"
(Bernanke then goes on to say, ?I need to tread carefully here?. I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by US policymakers to target the international value of the dollar.?
But this is the killer paragraph, “Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to +3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation”.
In other words Bernanke, if circumstances necessitate it, advocates direct foreign exchange intervention as a tried-and-tested route to reviving growth and eliminating deflation. QE has been dressed up by the Fed et al in a pretentious theoretic framework as working through a portfolio balance approach, driving interest rates so low that people are forced out of cash into financial assets, underpinning consumption via wealth effects. Let?s not beat around the monetary bush, one of the main aims of QE is to drive down one?s currency to gain a competitive advantage without overtly doing so. But, that mask is now lifting, with the ECB?s Draghi openly stating that a weaker euro was one of its main targets in adopting its QE programme.
Rather than pretending not to target the exchange rate and pursuing domestic money printing, which distorts domestic asset prices, raises inequality and only indirectly works to weaken the exchange rate, the next stage of the currency war will be direct FX intervention. China has pursued this course of action, after all, for most of the past decade.
Edwards' conclusion:
The BoJ will eventually have the veil lifted from its deluded eyes and accept that Japan?s recovery is stalling and that CPI inflation is not moving higher. And, if Japanese authorities read Ben Bernanke?s 2002 speech and believe they are running out of domestic financial assets to buy, they will find there are plenty more assets to buy to drive down the yen. They can follow the widely acknowledged expert in getting out of 1930s-style deflation and do as Bernanke suggests ?- buy assets abroad to directly target a lower yen. Impossible? So much of what we now accept as routine in financial markets would have been thought impossible prior to the 2008 crisis ?- the next logical stage in the global currency war will be direct fx intervention!
We can't wait, and neither can Virtu: just imagine the epic profits that frontrunning billions in FX trades coming directly form central banks, and no longer disguised via Citadel or Japanese Trust Banks, will lead to.
