Japan's Problems Will Not Be Solved By More QE, RBS Warns

One thing that became abundantly clear about QE long ago even if it hasn’t yet dawned on Mario Draghi or Haruhiko Kuroda, is that the practice of monetizing anything and everything that isn’t tied down (or that you can’t pry from the cold dead hand of an institutional investor), is subject to the law of diminishing returns. 

Put simply: eventually it just stops working in terms of stimulating aggregate demand and/or boosting growth and inflation expectations.

Unfortunately, the deleterious effects of QE are not subject to the same dynamic. 

That is, when you print another say, €750 million to monetize everything from periphery EGBs to SSAs to munis, you invariably impair market liquidity on the way to creating the conditions for dangerous bouts of volatility (see the great bund VaR shock for instance). 

Of course when you go full-Kuroda and simply corner the market for ETFs by stepping in to provide plunge protection at the first sign of Nikkei weakness, there’s no telling what kind of chaos you’ve set everyone up for once you step out of the market. Meanwhile, the mad dash to inflate the value of stocks and bonds has served to create enormous bubbles not only in those assets, but also in the things people who hold those assets are likely to buy when they get bored - like real estate and high end art. 

In short, the drug addiction analogy (as cliche as it now is) still holds up remarkably well. For a drug addict, the benefits (i.e. the high) diminishes the more the addiction grows, but the harmful effects on the body do not. It’s the same thing with QE. The initial “high” wears off, but the asset bubbles only grow. 

Nowhere is this more apparent than in Japan where just last night, we witnessed the unprecedented "quintuple recession": 

As if that wasn't bad enough, Japanese business spending dropped 1.3% QoQ - its worst drop since Q2 2014.

Of course the Nikkei is doing just fine, surging right alongside the BoJ's balance sheet.

In honor of Kuroda and his special brand of Peter Pan-inspired, neo-Keynesian madness, we present a bit of color from RBS' Alberto Gallo on Japan and QQE.:

QE infinity? Japan re-enters into recession; the Economy Minister suggests that labour unions are still stuck in a deflationary mind-set. The Japanese economy suffered a technical recession again in Q3, contracting -0.8% QoQ on an annualised basis, following a -0.7% drop in Q2.

Inflation has also fallen back again, reaching 0% in September (below). One major reason for this is weak wage growth. 


Why has QQE failed to boost growth and inflation for Japan? Cyclical tools are insufficient to tackle the country’s structural issues. Japan’s problem started in the 1980s, when firms increased debt by 14% of GDP per year to reach 130% of GDP by 1995 (BoJ). This was followed by two decades of slow corporate deleveraging, deflation/weak inflation, near-zero interest rates and compressed bond yields, albeit with few bond defaults. Under PM Abe, the Bank of Japan has stepped up monetary easing by initiating the Quantitative and Qualitative Easing (QQE) programme in April 2013 and expanding it in October 2014. 

However, the issues faced by Japan are more structural, including an ageing population, low investment appetite for corporates and a widespread deflationary mindset as suggested by Amari. 


Japan’s experience suggests that QE has its limits, and could bring a range of side effects, in our view. These include years of tepid growth (see below), the reduction in secondary trading liquidity, an increase in asset ownership by central banks (the BoJ now owns half of the national ETF market), potential formation of asset bubbles and social problems like inequality.



Ok, so in other words: Kuroda isn't going to be able cure the country's structural problems which include the well worn issue of Japanese demographics as well the much maligned "deflationary mindset" which seems largely immune to the hum of the BoJ's prinitng press. Nevertheless, Japan is all-in and is apparently prepared to keep the pedal to the floor until 2018 when, as we've documented extensively, the game will officially be up (see here for instance).

In the meantime, as Gallo rightly points out, you can expect an impaired secondary market for JGBs, asset bubbles, and rising inequality (all outcomes we've discussed at great length) as Kuroda triples, quadruples, and quintuples down on policies that now seem to be producing around one recession per QE iteration. 

Summed up...