Kuroda’s Monetary Policy Bazookas and the Failure of Abenomics

ADB's Kuroda Says Additional BOJ Easing Can Be Justified for '13
Haruhiko Kuroda, Governor of the Bank of Japan, speaks during an interview in Tokyo, Japan, on 11 February 2016. His stimulus programmes as BoJ head have sparked international controversy and discourse but have unfortunately ended in a resounding failure.

Since Haruhiko Kuroda became Governor of the Bank of Japan in 2013, he has implemented a labyrinth of monetary expansion initiatives, including the famous quantitative easing programme of ¥‎80 trillion per year and the negative interest rate policy. As a major tenet of the Abenomics reform package, this was intended to stimulate Japan’s ailing economy.

The most pressing issue for both Kuroda and Prime Minister Shinzo Abe is that these reforms did not—even remotely—achieve their desired goals. Inflation is nowhere near the 2% annual target and GDP growth is lacklustre. Since the dawn of the 2008 financial crisis, the Japanese economy has endured five recessions and GDP growth that is stagnant at best.

Abe’s reform package relies heavily on a weaker Yen to increase exports, raise corporate profits, and fight deflation, but this is not materialising either. Since January 2016, the Bank of Japan has improvised a -0.1% interest rate on many reserves and yet the currency has still increased 18% vis-á-vis the US dollar since the new target rate. The asset purchasing programme, which has now been implemented at the ECB as well, has resulted in the Bank of Japan holding 38% of Japanese government bonds. This astonishing figure is more than double the 14% of US government bonds held by the Federal Reserve after its quantitative easing scheme under Bernanke and Yellen.

In a desperate attempt to finally revitalise Japan’s economy, many observers are pointing to helicopter money as a means to increase aggregate demand and hopefully economic output. While this has not been implemented at the central bank level, Abe’s cabinet did approve a 13.5 trillion stimulus programme in August that focuses on public works spending. The recent appointment of Toshihiro Nikai, a long advocate of this variety of spending, as Secretary-General of the Liberal Democratic Party signifies Abe’s commitment to this new plan.

There is one significant problem with this new plan—it isn’t new at all. Following the burst of the Japanese property bubble in the early 1990s, several administrations, notably that of SPJ PM Tomiichi Murayama, initiated massive stimulus programmes in civil projects to jumpstart the economy. In fact, the massive demise of this policy was even used in the United States to argue against the Obama administration’s American Reinvestment and Recovery Act. Like many Western nations, the plight of the Japanese economy is the result of structural forces that are regulatory, tax-related, and demographic.

In their reckless aim to artificially boost the economy, Abe and Kuroda both fail to realise this. While the BoJ Governor said in late 2015 that negative rates were not an option, he proceeded to implement them in January the following year. Any denial of prospective helicopter money directly from the BoJ should likewise be viewed as a tentative hope for the future, not as an actual policy position. After the pledge of a “comprehensive review”, the BoJ has now decided to begin a new yield-curve monitoring programme during the late September meeting.

A glimmer of hope once existed for the Japanese economy: the Trans-Pacific Partnership. Unfortunately, due to populist forces fuelled by demagogues such as Bernie Sanders in the Western world and the Renho-led Democratic Party’s opposition to the deal, this lifeline is unlikely to come to fruition.

As Japan’s international competitiveness continues to decline, leaders in both the BoJ and National Diet will attempt to employ any method possible to save future generations from malaise…

…except the ones that actually work.


Outlook Worsened: Negative Rates from the Federal Reserve? Really?

Federal Reserve Janet Yellen
On 4 November 2015, Janet Yellen purported that the Federal Open Market Committee (FOMC) would be willing to lower the federal funds rate into negative territory if US economic conditions deteriorated further.

The United States faces many problems — a massive welfare state, complicated tax code, oversized government, over-regulated economy, and bloated education system. After a flurry of astigmatic regulation designed to promote home affordability created a $4 trillion housing bubble and ensuing financial crisis, most would hope that a nation as powerful as the US would finally get its act together. That pretence was simply false.

Since 16 December 2008, the FOMC has maintained a policy of 0% interest rates on federal funds, overnight funds traded between banks to maintain their deposits at the Fed. This was aimed to push interest rates far below Wicksellian (equilibrium) level and create another asset bubble. While this would result in another recession after a burst, the Fed has not been an organisation known to be concerned with long-term stability since the passage of the mandates set forth in the Federal Reserve Reform Act of 1977.

In addition, the FOMC maintained a policy of quantitative easing from 2008 to 2014. The policy  administered $3.5 trillion in asset purchases in the secondary market, with a goal of suppressing yields on government bonds to shift the allocations in investors’ portfolios to riskier assets such as stocks. Considering that the DJIA has more than doubled since the end of the financial crisis, QE clearly served its purpose in securities markets. In another respect, however, the program failed tremendously.

This current expansion is the slowest in the entire economic history of the United States. GDP growth has averaged 2.2% since the end of the financial crisis, far below the 1949-2007 long-term average of 3.25%. Wage growth is completely anaemic, with virtually no inflation-adjusted growth in the past six years. Government spending is approximately 40% of GDP and the country faces a regulatory burden of 12% of GDP. Despite all of these negative factors, both the Obama administration and Federal Reserve have attempted to convince the populace that the US economy is performing at an “optimal” level.

In recent months, however, many investors and consumers alike have started to discern the blatant attempts at misinformation. Equities markets are completely flat in 2015 so far and reports in consumer confidence are consistently falling. After the announcement that the US economy grew just 1.3% in the third quarter of 2015, the Federal Reserve itself began to shed its attitude of confidence and false optimism.

In the last FOMC meeting on 28 October, Narayana Kocherlakota, the President of the Federal Reserve Bank of Minneapolis, projected negative rates in the future. Many disregarded this as a deranged prediction from Kocherlakota, who is known for making erroneous statements on future monetary policy. On 4 November 2015, Janet Yellen, Chair of the Federal Reserve, claimed that the federal funds rates could be lowered to negative territory “if outlook worsened”. The radical fringe has suddenly become the voice of prophecy.

That same day, William C. Dudley, the President of the Federal Reserve Bank of New York, stated in an interview that “some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” referring to the disastrous negative interest rate policy set forth by the European Central Bank. Mario Draghi, the President of the European Central Bank, hinted that rates could be lowered further if the condition of Europe’s economic condition somehow gets even worse.

The harsh truth that has emerged since the end of the financial crisis is that expansionary monetary policy does not lead to higher economic growth in the sustainable sense. Expansion of the money supply and artificially lowering interest rates only serve to create an asset bubble, which is present in the US, Canada, and Europe. Negative interest rates will only make this conundrum even more difficult to rectify after the respective bubble bursts. Instead of focusing on short-term shortcuts that lead to economic malaise in the future, the West should begin fixing its long-term problems.

Overinflated and Bursting: Growth Prospects of the US, China, and Global Trade

The port of Singapore is the world's largest transshipment port. Global trade growth is projected to clock in at 3.2% in 2015, the worst performance since the Great Recession.
The port of Singapore, depicted, is the world’s largest transshipment port. Global trade growth is projected to clock in at 3.2% in 2015, the worst performance since the Great Recession.

The International Monetary Fund has again cut its forecast for global GDP growth in its World Economic Outlook, which is now only 3.1%, a decrease of 30 bps from 2014. This is during a time in which the vast majority of the world’s central banks have lowered their discount rate, with some even adopting NIRP. To complicate matters even more, the European Central Bank is in the process of massive quantitative easing program, while the Bank of Japan is anticipated to resume theirs towards the end of October.

This week global growth is based almost solely on asset bubbles created by the economic distortions of central banks. The Federal Reserve in the United States is perhaps the most infamous example, when it purchased $3.7 trillion in securities through open market operations in three rounds of QE from 2009 to 2014. Equity markets in the US are still in this bubble, albeit without quantitative easing, the bull market is beginning to reflect signs of subsiding.

The fundamentals of the US economy are disturbingly weak during this expansion, leaving many to wonder if the Federal Reserve will raise the federal funds rate in the next FOMC meeting. PCE is currently at 0.3% on an annualised basis, far below the level the Fed would consider optimal for raising rates. The latest BLS report was an abject disappointment with only 142,000 jobs added in September and labour force participation diving to a 38-year low of 62.4%. Considering these reports, it is unlikely that a rate hike will occur, however if it does, it will most likely be a small 25 bps, which could place this current bubble in jeopardy.

Projections from the IMF report peg US GDP growth at 2.6% in 2014. This will be strenuously difficult to achieve, as the latest data from the Federal Reserve Bank of Atlanta’s GDPNow index nowcast third quarter growth at 0.9% annualised, combined with 0.6% in Q1 and 3.9% in Q2.

A large feature of the WEO focuses on the state of the Chinese economy. The nation recently underwent the correction of a bubble in the equity market, which quickly prompted liquidity support and trading restrictions from the People’s Bank of China and China Securities Regulatory Commission, respectively. Despite these measures, the Shanghai Composite rests at just over 3,000 at 6 October market closing, equal to the trough evident in late August. Li Keqiang stated on 10 September that the PBOC will not begin a quantitative easing program, which signifies that the Communist Party has finally obtained an elementary level of competence. Due to this burst and subsequent slowdown, the report projects Chinese GDP to grow at under 7% in 2015, the rate long regarded as a technical support.

The highlight of the WEO also the most depressing inclusion. Global trade, which is less affected by myopic actions of central banks, is predicted to grow at only 3.4% in 2015. This level is the lowest seen since the end of the financial crisis of 2008-09 and is unconventionally low during an economic expansion. Global trade has grown significantly faster than other components of the world economy due to increasing levels of globalisation. Growth rates this low reflect that GDP growth is propped up only by central banks.

Despite the plead of many economists, global central banks have continued easing their monetary policy, the only exception being the Reserve Bank of India, and have produced asset bubbles combined with economic stagnation as a result. Many problems facing the world economy, ranging from overregulation to high welfare spending to a lack of property rights, will not be rectified, as the motives for reform are greatly inhibited by the constant cycles promulgated by central banks. While another financial crisis is not the most desirable outcome, it is the only way to restore the proper function of price discovery and create a pathway for policy reform, both from central bank and government.

NASDAQ 5,000: Are We In Another Bubble?

The NASDAQ 5000 has increased exponentially since the trough of the Great Recession despite low economic growth, leading to the consensus that Fed policy has created another asset bubble.
The NASDAQ Composite has increased exponentially since the trough of the Great Recession despite low economic growth, leading to the consensus that Fed policy has created another asset bubble. Many bull market economists dispute this view, mirroring thoughts during the height of the dot-com bubble.

Given the poor economic performance of the United States in recent years, it surprises many that the NASDAQ Composite has nearly returned to its highs during the dot-com era, which was the longest economic expansion in US history. This regained milestone also poses another question: is the US economy currently experiencing a market bubble?

The March 1991 to March 2001 economic expansion was the longest and largest of any in United States history. US GDP grew at above 4% annually in 1997 (4.5%), 1998 (4.5%), 1999 (4.8%), and 2000 (4.1%). The NASDAQ Composite reached an intraday high of 5132.52 on 10 March 2000, before diving to 1108.49 on 18 October 2002. The combination of the failure of FCC-mandated CLECs, burst of the dot-com bubble, and a flurry of accounting scandals (Tyco, WorldCom, Enron) weighed heavily on the technology-dominated index.

It should not shock many that the US’s economic performance is more dismal than during the dot-com boom. GDP growth was 2.4% in 2014, and has never reached above 3% since the Great Recession. Despite this, the massive accumulation of corporate debt in recent years (especially in the technology sector) mirrors the same trend during the financial crisis. Overvaluations and high price-to-earnings ratios concern many economists.

Peter Schiff, CEO of Euro Pacific Capital, voiced that Uber’s latest $41 billion “valuation is absurd. And there’s a lot of companies like Uber that are sporting these billion-dollar market caps.”  Wild overvaluations are not the only symptom of the current bubble. There’s been a major move to more speculative investments due to low interest rates. This is evidenced by the recent rise in stock buybacks that public companies have facilitated. After accounting for inflation, many savings accounts, certificates of deposit, and Treasury securities generate negative real returns. This will later end in financial capitulation, or flight to quality, as traders will be forced to expunge riskier assets from their portfolio after the bubble bursts.

The Federal Reserve’s $3.7 trillion quantitate easing program was aimed to stimulate investment after the Great Recession by purchasing bank debt, mortgage-backed securities, and Treasury notes. QE has clearly pushed up asset prices above equilibrium levels, causing massive amounts of malinvestment in the economy. The Fed’s only option is to facilitate a discount rate increase within the next year, thus bursting the current bubble.

Economic conditions revolve less around timing of interest rate increases than Fed response to the ensuing financial crisis due to cash flow management difficulties that arise from an increase in debt service costs, among other results aforementioned. My worry is that the FOMC will use the downturn to begin QE4, creating another asset bubble. Poor policy by the Fed in recent years has made many reconsider the central bank’s role in the economy, for better or worse. Perhaps optimal monetary policy will one day set the stage for solid, real economic growth.