Money Printing: Rajan Launches QE Lite to Bring Down Interest Rates

ARTS RAJAN

In the first monetary policy statement for this financial year, Raghuram Rajan, the governor of the Reserve Bank of India(RBI) cut the repo rate by 25 basis points to 6.5%.

One basis point is one hundredth of a percentage. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the short and medium term interest rates in the economy.

In the column dated March 30, 2016, I had said that it is best if the RBI cuts the repo rate 25 basis points at a time and not more.

My logic for writing this was fairly straightforward. From January 2015 onwards, the RBI had cut the repo rate by 125 basis points. In comparison, the banks had cut their lending rates by only around 60 basis points. Meanwhile, they have cut the interest rates on their fixed deposits by more than 100 basis points.

This means that the banks have cut their lending rates at a very slow pace. Hence, there was no point in the RBI cutting the repo rate by more than 25 basis points, given that the banks have not passed on that cut to their prospective and current borrowers, in the form of lower lending rates.

In this scenario the best strategy for the RBI is to cut the repo rate 25 basis points at a time and then take a check if the cut has been passed on to the borrowers by banks.

And this is precisely what Rajan did yesterday by cutting the repo rate by 25 basis points. Honestly, the cut in the repo rate was not the most important part of yesterday’s monetary policy statement.

In the most important paragraph of the monetary policy, the RBI said that it will “continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL [net demand and time liabilities] to a position closer to neutrality.”

What does this mean in simple English? There is a certain demand for money that the banking system has. But there is only a certain supply of it going around which is not enough to fulfil demand. The difference is referred to as liquidity deficit.

Hence, banks cannot borrow as much as they want to from the banking system. In this scenario they have to pay a higher rate of interest to borrow.

The monetary policy statement of the RBI puts the liquidity deficit at 1% of demand and time liabilities. This means that the liquidity deficit in the banking system is at 1% of the total current account deposits, savings account deposits and fixed deposits, of banks.

As on March 18, 2016, the total demand and time deposits of banks stood at Rs 93,786,60 crore. The liquidity deficit is 1% of this and hence works out to around Rs 93,786 crore. This is where theoretically the deficit in the banking system should have been.

But the actual deficit is more than this. Rajan in his interaction with the media after presenting the monetary policy conceded that the actual liquidity deficit was around Rs 50,000-60,000 crore more than the RBI had estimated. This means that the actual daily liquidity deficit is around Rs 1,50,000 crore.

There are multiple reason for the same. Assembly elections are currently on in several states. Around this time, the cash in hands of the public increases. As Rajan said: “you can guess as to reasons why…we also guess.” This increase is not only in the states that go to elections but also in neighbouring states.

Then there was the issuance of tax-free bonds. Further, before the interest rates on small saving schemes were cut there was an inflow of money into these schemes. All these factors have essentially ensured that the liquidity deficit in the banking system is around Rs 1,50,000 crore.

The RBI now plans to bring down this deficit to a position closer to neutrality. The RBI plans to steadily reduce this deficit. The question is how will the RBI do this? The central bank will have to buy assets from banks.

One way of going about it is to carry out open market operations and buy bonds from banks. In fact, the RBI announced an open market operation of Rs 15,000 crore, yesterday.

The question is where will the RBI get this money from? The RBI, like any other central bank, has the ability to create money out of thin air by printing it, or rather by creating it digitally these days.

And this is precisely what the RBI will do—it will print money to buy bonds. When it buys bonds, it will pay for it through this freshly created money. When this freshly created money enters the banking system, the supply of money will go up and the liquidity deficit will come down. This will push down interest rates and in the process banks will pass on lower interest rates to the end consumers.

Of course this is not going to happen overnight and will happen over the course of this financial year and perhaps even the next.

In fact, what the RBI is trying to do is similar to what happened in the aftermath of the financial crisis that started in September 2008. The Federal Reserve of the United States decided to print money and buy bonds, in order to drive down interest rates, so that people would borrow and spend more. This is referred to as quantitative easing or QE.

The RBI is also doing a smaller version of QE. We can perhaps call it QE lite.

There were other moves also to help banks lower lending interest rates. Up until the RBI had maintained a difference of 100 basis points between the reverse repo rate and the repo rate.

While repo rate is the rate at which the RBI lends to banks, the reverse repo rate is the rate at which the RBI borrows from banks. Before today, the repo rate was at 6.75% and the reverse repo rate was at 5.75%. The difference, as mentioned earlier, was 100 basis points.

The RBI cut the repo rate by 25 basis points to 6.5%. At the same time, it increased the reverse repo by 25 basis points to 6%, thus narrowing the difference to 50 basis points. Hence, banks will now pay a lower interest when they borrow from the RBI and get a higher interest when they have excess funds, which they can park at the RBI. This basically will help banks to earn more and make it more likely for them to cut their lending rates.

Further, banks need to maintain 4% of their demand and time deposits with the RBI as a cash reserve ratio(CRR). Currently, the banks need to maintain 95% of the required CRR with banks on a daily basis. This has been lowered to 90%. This will help ease the pressure on banks and they will have more free cash. This should again help them cut their lending rates.

Up until now, the RBI repo rate cuts led to interest rate on deposits being cut more rapidly than lending rates. This time around, the lending rates are also likely to be cut.

Watch this space!

The column was originally published on Vivek Kaul’s Diary on April 6, 2016

Bill Bonner: “We Have Got a Lot More Nonsense Coming”

bill bonner
Dear Reader,

This is the second part of the interview with Bill Bonner.

He founded Agora Inc. in 1979. With his friend and colleague Addison Wiggin, he co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster.

In this interview Bill tells us that “We have got a lot more, a lot more nonsense coming and I think it’s going to come first from Europe where Draghi is going to come up with a lot more QE like stuff.  We don’t know exactly what or when.”

Happy Reading!
Vivek Kaul
Iceland just sent its 26th banker to prison. As far as I know not a single US banker or someone from Wall Street has gone to jail. Rajat Gupta and Raj Rajaratnam have, but their cases were different. They had nothing to do with the financial crisis.

Ah! I am not sure, but as far as I know no banker specifically has been gone to jail as a result of the crisis.  I don’t know what to make of it.  I am hesitant to condemn the bankers.

I mean they were playing the game when in effect, they were the ones who made the rules. They bribed the politicians to make the rules and they played by those rules. Did they break the rules?  I don’t know.

Why do you say that?

I have been involved in the financial industry in America for a long time. What I do know is, those rules are very tough to understand. If anybody wants to put you in jail, they can put you in jail because it’s sure that you are violating some rule somewhere. There are too many of them.  So I am little bit sympathetic to the bankers in that particular aspect about being convicted of crimes. But I am not at all sympathetic to them in the broader sense because as I said they created that system. I don’t think they deserve to go to jail because I would bet those rules are pretty non-screwy. I do bet they deserve to go broke and that’s what would have happened and that’s the way the market works.

But these guys escaped…

The market doesn’t put you in jail just because you bet on the wrong banker.  But the market has a way of taking care of these problems and it was on its way to taking care of these problems in a big way in 2008, when half of Wall Street was exposed to bankruptcy. Half of those institutions probably would have gone broke and half would have been broken up and sold. That would be a punishment and getting what one deserves. That to me makes sense. Instead of that, the government came in and gave these people money. It gave the people who had made such bad bets even more money to make even bigger bets and then it claimed to be enforcing the law. The wrong doers were too close. They all were too cozy there.

That’s a nice way of putting it…

So my guess is that in Iceland their financial industry did not lobby correctly.  But the end of it was that the financial industry got away scot free and got away with all of their ill-gotten gains and went on to make even more money as the Fed gave them money in the terms of zero interest rate financing.  So the whole thing is absolutely preposterous in every sense and offensive.

Your new book is called “Hormegeddon: How Too Much of a Good Thing Leads to Disaster.”  So can you elaborate a little on the subtitle of the book, “How too Much of a Good Thing Leads to Disaster.”  Why do you say that?

Well there is a famous quote in America by Mae West, who said, “Too much of a good thing is wonderful.”  The thing that she was talking about might be the only thing that too much of is wonderful.  But most things are like sugar. You think, well, I will have a chocolate pudding for dessert and one chocolate pudding is wonderful, two chocolate puddings is okay.  By the time the third chocolate pudding comes around, you begin to say um, I am not sure about this and by the fourth you begin to feel a little sick. If you keep eating chocolate puddings, it is not going to be good for you. So that’s true of almost anything.

By the way the economists have a rule for this called the principle of declining marginal utility and it seems to apply to just about everything.  No matter what you try to do or what you think.

Can you give us an example?

It applies to money. When you have no money and somebody gives you 10 dollars, that 10 dollars, each one of those dollars is very very valuable to you and if you have a million dollars and somebody gives you 10 dollars you really are not going to be impressed at all because the value of that money has declined.  Each additional incremental dollar declines to the point where it is almost worth nothing. We read in the papers that multibillionaires like Zuckerberg have given away 50 billion dollars and that is such a great thing. But actually those 50 billion dollars really had no value.

What do you do when you already have the house that you want…you already have the car that you want… and you can’t eat any more chocolate desserts…no matter how much money you have…you cannot buy another car…what are you going to do with it?

You only have a certain number of hours in a day…you can only watch so many movies…you can only do this…you can only do that…so you reach a point where the extra money that you get has a marginal utility that has declined to zero and then below zero.  Because you have to take care of it, you have to think about it and you have to protect it.  And so when a billionaire has 100 billion dollars and he gives away 50, well I don’t know if he has given away that much.

But anyway, the principle applies to everything.

Can you give us some more examples?

It applies to security, one of the cases that I explained in the book.  Now you would say well security; you can’t be too safe and that’s what they tell you when you go through the line at the airport and there is a grandmother in front of you and they are checking her out thoroughly making her go through twice and panning her down and you are thinking in what way does she pose a threat to anybody and then a voice comes out that says, “you cannot be too safe.”

But in fact you can be too safe and because everything that you do in that direction involves expending money and time and resources that could be used for something else.

Can you give us an example?

In the extreme example that I used in the book—In Germany after the First World War, it felt very unsafe, you know they had capitulated in the war and the allies that is to say France, America and Britain were not at all sympathetic. So Germany felt terribly exposed and they were not allowed even to have an army. 

So along came Adolf Hitler and he said, “Enough of this, I am going have an army anyway.” And he began investing German money in the security industry and at first it seemed like the right thing to do.  And at first the viewers, especially the foreign viewers, who really didn’t know what was going on, they thought that this was great. Germany was getting back on its feet and their factories were hustling again. Everything seemed to be going in the right direction.

But Adolf Hitler did not stop with a little bit of security, he wanted a lot of security and more and more of the German economy, was shifted from domestic production to military production and the result of this was that it shifted people’s minds too, because pretty soon a lot of the German workforce actually worked for the defence industry and a lot of people had children, sons, daughters, nephews in the army. Everybody became very sympathetic to the army, to the defence industry and after years of propaganda to the idea that Germany needed its place in the sun and the way to get it was with military force.

So they launched on this adventurism which they started in 1939 and the result of that we all know.  It was disastrous. It ended in the worst possible way for Germany where all of that security bought them no security at all.  It was counterproductive. It was a negative pay off.  They had gone from when they had too much of a good thing, security being a good thing, to the point where they had no security at all.  And that’s true in a lot of things, I mean that principle.

How do you link this to the current financial crisis?

Well you could say almost exactly the same thing about credit.  A little bit of borrowing is a good thing and the credit has proven to be useful in many circumstances. In fact, credit is as old as the hills and even before there was money there was credit.

Credit right.

Yeah there was debt and people would remember in small tribes. Anthropologists have done a lot of study of this.  They found that people would remember that somebody gave them chicken or somebody gave them an arrowhead or somebody’s daughter was exchanged to one family and they owe them a daughter or something or another.  And they remembered.  They had long memories of this stuff.  So credit is basically something that has been around for a long time and surely a little bit of credit seems to help an economy, but too much credit and then you end up with these funny things happening as we have in the world today.

For sure…

And by the way world credit is astounding in its growth; in 1995, which is 20 years ago, the entire world credit was 40 trillion dollars; today it’s 225 trillion.  That’s in a period in which the GDP has risen like 2% per year.  This is a phenomenal separation of the real economy from the Wall Street economy; The Wall Street economy being an economy of debt, assets, financial instruments, etc.  So we have this huge diversion.

We have seen also the same sort of thing, a declining marginal utility of debt, where each additional dollar invested in debt has produced less and less GDP payoff.  And so at the end, in 2009, we were seeing huge increases in debt with no increase in GDP and that’s what is happening again today, where debt is still going up at a very high rate and the GDP growth has declined in America to about a zero. In fact, it might be zero and it might be negative, we are waiting for the figures for the last quarter to come out, but there are some people guessing that the next quarter is going to be a recessionary.

Given that the next quarter is going to be recessionary, how do you see Janet Yellen and the federal open market committee going about increasing the federal funds rate…

Oh! I don’t think they will and I don’t think they can.  I think that it’s…

Will they reverse the cut?

They won’t want to because you know they have staked their short term reputations on this idea that the economy is recovering and that therefore they can normalise interest rates.  They are all in cahoots by the way. Also, these guys talk to one another. I think what they are counting on is Mario Draghi [the President of European Central Bank] to reinvigorate the European economy with a lot of credit, because he has been generally not done as much.

So Draghi came out and said that he would do whatever had to be done and he said that there were no limits to what he would do.  And right after that the world stock markets went up.  Yellen would much prefer for Draghi to do the heavy lifting this time and my guess is that they have a lot more they can do and I don’t think we have reached the end of this cycle at all.  I think we have got a lot more, a lot more nonsense coming and I think it’s going to come first from Europe where Draghi is going to come up with a lot more QE like stuff.  We don’t know exactly what or when.

You see Yellen going back to QE?

I do, but not quickly.  First they are hoping that the Europeans will do enough. If the Europeans put out enough cheap money it ends up in America any way because the Europeans want to buy US treasury bonds in order to protect their money so that’s probably what will happen.  

I think it really depends on how effective the Europeans are. If the Europeans are not effective and we get another big wave downward in the US markets and we go into a recession in the first quarter, I think then first they will announce that they will not do any further hikes. Then maybe they will come with some QE program or something, but there is no way in which they are going to allow a real correction.  A real correction is the severe serious thing. All of their training and their institutional momentum, all of that goes towards solving these problems rather than letting them solve themselves.

Thank you Bill.

Thank you.

Concluded…

The interview originally appeared on the Vivek Kaul Diary on Equitymaster

You can read  the first Part of the interview here 

Yen carry trade from Japan will drive the Sensex higher

Japan World Markets

Vivek Kaul 

John Brooks in his brilliant book Business Adventures writes “The road to Hell is paved with good intentions!” One country on which this sentence applies the most is Japan. The country has been trying to come out of a bad economic scenario for two decades and it only keeps getting worse for them, despite the effort of its politicians and its central bank.
In the previous column, I wrote about how the prevailing economic scenario in Japan will ensure that they will continue with the “easy money” policy in the days to come, by printing money and maintaining low interest rates in the process.
But it looks like the situation just got worse for them. The Japanese economy contracted at an annual rate of 1.6% during the period July-September 2014. This after having contracted at an annual rate of 7.1% in April-June 2014. Two consecutive quarters of economic contraction constitute a recession.
Shinzo Abe was elected the prime minister of Japan in December 2012. His immediate priority was to create some inflation in Japan in order to get consumer spending going again. The Bank of Japan cooperated with Abe on this, and decided to print as much money as would be required to get inflation to 2%. This policy came to be referred as “Abenomics”.
In April 2013, the Bank of Japan decided to print $1.4 trillion and use it to buy bonds, and hence, pump that money into the financial system. The size of the Japanese economy is around $5 trillion. Hence, as a proportion of the size of Japan’s economy, this money printing effort was twice the size of the Federal Reserve’s third round of money printing, more commonly referred to as the third round of quantitative easing or QE-III.
Sometime in April this year, the Abe government decided to increase the sales tax from 5% to 8%. The idea again was to raise prices, by introducing a tax, and get people to start spending again. Nevertheless, this backfired big time and the economy has now contracted for two consecutive quarters.
Elaine Kurtenbach writing for the Huffington Post points out Housing investment plunged 24 percent from the same quarter a year ago, while corporate capital investment sank 0.9 percent. Consumer spending, which accounts for about two-thirds of the economy, edged up just 0.4 percent.”
Towards the end of October 2014, the Bank of Japan decided to print $800 billion more because the inflation wasn’t rising as the central bank expected it to. Now with the economy contracting again, there will be calls for more money printing and economic stimulus. In fact, after GDP contraction number came out,
Etsuro Honda, an architect of Abenomics, told the Wall Street Journal that it was “absolutely necessary to take countermeasures.”
While the “easy money” policy run by the Japanese government and the central bank hasn’t managed to create much inflation, it has led to the depreciation of the yen against the dollar and other currencies.
In early November 2012, before Shinzo Abe took over as the prime minister of Japan, one dollar was worth 79.4 yen. Since then, the yen has constantly fallen against the dollar and as I write this on the evening of November 18, it is worth around 117 to a dollar.
Interestingly, some inflation that has been created is primarily because of yen losing value against the dollar. This has made imports expensive. The consumer price inflation(excluding fresh foods) for the month of September 2014 came in at 3%.
Once adjusted for the sales tax increase in April, this number fell to a six month low of 1%, still much below the Bank of Japan’s targeted 2% inflation.
Analysts believe that the yen will keep losing value against the dollar in the time to come. John Mauldin wrote in a recent column titled
The Last Argument of Central Bankers The yen is already down 40% in buying power against a number of currencies, and another 40-50% reduction in buying power in the coming years is likely, in my opinion.”
Albert Edwards of Societe Generale is a little more direct than Mauldin and wrote in a recent research report titled
Forecast timidity prevents anyone forecasting ¥145/$ by end March – so I will “The yen is set to…[crash] through multi-decade resistance – around ¥120. It seems entirely plausible to me that once we break ¥120, we could see a very quick ¥25 move to ¥145 [by March 2015].”
Edwards further writes that he expects “
the key ¥120/$ support level to be broken soon and the lows of June 2007 (¥124) and Feb 2002 (¥135) to be rapidly taken out.” The note was written before the information that the Japanese economy had contracted during July-September 2014, came in.
This makes the Japanese yen a perfect currency for a “carry trade”. It can be borrowed at a very low rate of interest and is depreciating against the dollar. Before we go any further, it is important that we go back to the Japan of early 1990s.
The Bank of Japan had managed to burst bubbles in the Japanese stock and real estate market, by raising interest rates. This brought the economic growth to a standstill.
After bursting the bubbles by raising interest rates, the Bank of Japan had to start cutting interest rates and soon the rates were close to 0 percent. This meant that anyone looking to save money by investing in fixed-income investments (i.e., bonds or bank deposits) in Japan would have made next to nothing.
This led to the Japanese looking for returns outside Japan. Some housewife traders started staying up at night to trade in the European and the North American financial markets. They borrowed money in yen at very low interest rates, converted it into foreign currencies and invested in bonds and other fixed-income instruments giving higher rates of returns than what was available in Japan.
Over a period of time, these housewives came to be known as Mrs Watanabes and, at their peak, accounted for around 30 percent of the foreign exchange market in Tokyo, writes Satyajit Das in
Extreme Money.
The trading strategy of the Mrs Watanabes came to be known as the yen-carry trade and was soon being adopted by some of the biggest financial institutions in the world. A lot of the money that came into the United States during the dot-com bubble came through the yen-carry trade.
It was called the carry trade because investors made the carry, that is, the difference between the returns they made on their investment (in bonds, or even in stocks, for that matter) and the interest they paid on their borrowings in yen.
The strategy worked as long as the yen did not appreciate against other currencies, primarily the US dollar. Let’s try and understand this in some detail. In January 1995, one dollar was worth around 100 yen. At this point of time one Mrs Watanabe decided to invest one million yen in a dollar-denominated asset paying a fixed interest rate of 5 percent per year.
She borrowed this money in yen at the rate of 1 percent per year. The first thing she needed to do was to convert her yen into dollars. At $1 = 100 yen, she got $10,000 for her million yen, assuming for the ease of calculating that there was no costs of conversion.
This was invested at an interest rate of 5%. At the end of one year, in January 1996, $10,000 had grown to $10,500. Mrs Watanabe decided to convert this money back into yen. At that point, one dollar was worth 106 yen.
She got around 1.11 million yen ($10,500
× 106) or a return of 11 percent. She also needed to pay the interest of 1 percent on the borrowed money. Hence, her overall return was 10 percent. Her 5 percent return in dollar terms had been converted into a 10 percent return in yen terms because the yen had lost value against the dollar.
But let’s say that instead of depreciating against the dollar, as the yen actually did, it instead appreciated. Let’s further assume that in January 1996 one dollar was worth 95.5 yen. At this rate, the $10,500 that Mrs Watanabe got at the end of the year would have been worth 1 million yen ($10,500 × 95.5) when converted back into yen.
Hence, Mrs Watanabe would have ended up with the same amount that she had started with. This would have meant an overall loss, given that she had to pay an interest of 1 percent on the money she had borrowed in yen.
The point is that the return on the carry trade starts to go down when the currency in which the money has been borrowed, starts to appreciate. Since its beginnings in the mid-1990s, the yen carry trade worked in most years up to mid-2007. In June 2007, one dollar was worth 122.6 yen on an average. After this, the value of the yen against the dollar started to go up over the next few years.
With the yen expected to depreciate further against the dollar, it will lead to big institutional investors increasing their yen carry trades in the days to come. This will mean money will be borrowed in yen, and invested in financial markets all over the world.
Some of this money will find its way into the stock and the bond market in India. Moral of the story:
The easy money rally is set to continue. The only question is till when?
Stay tuned!

The article originally appeared on www.equitymaster.com on Nov 19, 2014

Is the stock market rally for real or will the bubble burst soon?

bubble

The BSE Sensex closed at 28,177 points on November 17, up by around half a percent from its last close. Its been good going for the Sensex, having rallied by 33.3% since the beginning of this year. This probably led to a reader asking me on Twitter whether the stock market rally was for real or would the bubble burst soon?
These are essentially two questions here. First, whether the current rally is a bubble? Second, how long will it last? These are not easy questions to answer. Also, instead of trying to figure out whether the current rally is a bubble or not, I will stick to answering the second question, that is, how long will the current rally last.
As I have
written on a few occasions in the past, the current rally is being driven by foreign institutional investors (FIIs). The domestic institutional investors(DIIs) have had very little role to play in it. The FIIs have made a net investment of a little over Rs 68,000 crore since the beginning of the year. During the same period the DIIs have made net sales of Rs 32,468 crore.
This data makes it very clear who has been driving the market up. Given this, instead of trying to figure out whether the current market is a bubble or not, it makes more sense to figure out whether the FIIs will keep bringing in fresh money into the Indian stock market.
The foreign investors have been borrowing money at very low interest rates and investing it in financial markets all around the world. They have been able to do that because Western central banks have been printing money to maintain low interest rates.
The Federal Reserve of the United States (the American central bank) recently decided to stop printing money and almost at the same time, the Bank of Japan decided to increase it. The Japanese central bank will now print around 80 trillion yen per year. The central bank had been printing around 60-70 trillion yen since April 2013, when it got into the money printing party, big time.
Like other central banks it pumped this money into the financial system by buying bonds. Interestingly, the size of the balance sheet of the Bank of Japan stood at around 164.8 trillion yen in March 2013. Since then, it has increased dramatically and as of October 2014 stood at 286.8 trillion yen.
The Bank of Japan hopes that by printing money it will manage to create some inflation. Once people see the price of goods and services going up, they will go out and shop, in the hope of getting a better deal. Also, with all the money printed and pumped into the financial system, interest rates will continue to remain low. And at low interest rates people were more likely to borrow and spend. Once people start to shop, it will lead to economic growth. Japan has had very little economic growth over the last two decades.
The trouble is that the Japanese aren’t falling for this oft tried central bank formula. And there is a clear reason for it. James Rickards in his book
The Death of Money explains the point using what Eisuke Sakakibara, a former deputy finance minister of Japan, said in a speech on May 31, 2013, in South Korea.
As Rickards writes “Sakakibara…pointed out that Japanese people are wealthy and have prospered personally despite decades of low nominal growth. He made the often-overlooked point that because of Japan’s declining population, real GDP per capita will grow faster than aggregate GDP. …Combined with the accumulated wealth of the Japanese people, this condition can result in well-to-do-society even in the face of nominal growth that would cause central bankers to flood the economy with money.”
The question to ask here is will the Japanese continue to print money? The answer is yes. The Japanese politicians are desperate to create some inflation and the central bank has decided to get into bed with them. Also, more than that the Japanese government spends much more than it earns and needs to be bailed out by the Bank of Japan.
As analyst John Mauldin wrote in a recent column titled
The Last Argument of Central Banks According to my friend Nouriel Roubini, in 2013 Japan’s total tax revenue fell to a 24-year low. Corporate tax receipts fell to a 50-year low. Japan now spends more than 200 yen for every 100 yen of tax revenue it receives. It is likely Japan will run an 8% fiscal deficit to GDP this year, but the Bank of Japan is currently monetizing at a rate of over 15% of GDP, thereby theoretically reducing the level of debt owed by government institutions other than the central bank.”
Fiscal deficit is the difference between what a government earns and what it spends.
What Mauldin basically means is that a part of the debt raised by the Japanese government is being repaid through the Bank of Japan printing money and lending it to the government. With all this money continuing to float around in the financial system, interest rates in Japan will continue to remain low.
This will allow large financial institutions to borrow money at low interest rates in Japan and invest it in financial markets all over the world, including India.
The European Central Bank (ECB) also seems to be in the mood to start quantitative easing (QE, i.e. printing money to buy bonds). As
Mohamed A. El-Erian, Chief Economic Adviser at Allianz wrote in a recent column “In fact, ECB President Mario Draghi signaled a willingness to expand his institution’s balance sheet by a massive €1 trillion ($1.25 trillion).”
While the United States might have decided to stop printing money, Japan and the Euro Zone, want to take a shot at it. Interestingly, chances are that the United States might go back to money printing in the years to come. As
Niels C. Jensen writes in The Absolute Return Letter for November 2014 “If my growth expectations are about correct, QE is far from over – at least not in some parts of the world, and it is even possible that the Fed[the Federal Reserve of the United States] will come creeping back after having distanced itself from QE recently.”
The Federal Reserve of the United States has been financing the American fiscal deficit by printing money and buying treasury bonds issued by the government. In mid September 2008, around the time the financial crisis started, the Fed held treasury bonds worth $479.8 billion dollars. Since then, the number has shot up dramatically and as on October 29, 2014,
it stood at $2.46 trillion dollars.
The fiscal deficit of the United States government shot up in the aftermath of the financial crisis. It was financed by more than a little help from the Federal Reserve. Nevertheless, the fiscal deficit has now been brought down. As Mauldin points out “T
he 2014 government deficit will be only 2.8% of GDP (it last saw that level in April 2005), the first time in a long time it has been below nominal GDP.”
The bad news is that the fiscal deficit will start rising again in 2016. “It is projected to fall again next year before rising in 2016. For the United States, this represents a reprieve, allowing us some time to deal with potential future problems before government spending rises to a proportion of income that is impossible to manage without severe economic repercussions. Government spending on mandated social programs will rise more than 50%, from $2.1 trillion this year to $3.6 trillion in 2024, potentially blowing the deficit out of control,” writes Mauldin.
The Federal Reserve might have to start printing money again in order to finance the government fiscal deficit.
Moral of the story: There are enough reasons for the Western nations to continue printing money and ensuring low interest rates. This means, FIIs can continue to borrow money at low interest rates and invest it in financial markets all over the world, including India.
The easy money party hasn’t ended. The only condition here is that the current government should not create a negative environment like the previous one did.
To conclude,
the difficult thing to predict is, until when will this easy money party continue. I don’t have any clue about it. Do you, dear reader?

The article originally appeared on www.equitymaster.com on Nov 18, 2014

Sensex hits record high: Now Japan takes over the easy money party from the US

japanVivek Kaul

Two days after the Federal Reserve of the United States brought to an end its money printing programme, the Bank of Japan decided to do exactly the opposite. In a surprise move the Japanese central bank on Friday (October 30, 2014) decided to increase the amount of money it has been printing to get the Japanese economy up and running again.
The Bank of Japan will now print 80 trillion yen (or around $727 billion) per year. The central bank has been printing money since April 2013 and was earlier targeting around 60-70 trillion per year. It pumped this money into the financial market by buying Japanese bonds.
In fact, the Bank of Japan entered the money printing party rather late. The money printing efforts of the Japanese central bank in the aftermath of the financial crisis were rather subdued and it had expanded its balance sheet (by printing yen and buying bonds) by only 30% up to December 2012. And then things changed.
This was after Shinzo Abe took over as the Prime Minister of the country on December 26, 2012. He promised to end Japan’s more than two decades old recession through some old-fashioned economics, which has since been termed as Abenomics.
Abenomics is nothing but money printing in the hope of creating some inflation. Abe’s plan was to get the Bank of Japan to go in for money printing and use the newly created “yen” to buy Japanese bonds.
By buying bonds, the central bank ended up pumping the printed money into the Japanese financial system. The hope was that all this extra money in the financial system would lead to lower interest rates. At lower interest rates people would borrow and spend more, and in the process the government would manage to create some inflation, as more money would chase the same amount of goods and services.
The Bank of Japan, the Japanese central bank, went with the government on this and is targeting an inflation of 2 percent. It wants to reach the goal at the earliest possible date, by printing as much money as maybe required.
And how will that help? In December 2012, Japan had an inflation rate of –0.1 percent. For 2012, on the whole, inflation was at 0 percent, which meant that prices did not rise at all. In fact, for each of the years in the period 2009–2011, prices had fallen in Japan.
When prices are flat, or are falling, or are expected to fall, consumers generally tend to postpone consumption (i.e., buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses, as their earnings either remain flat or fall. This slows down economic growth.
On the other hand, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So, by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decades old recession.
In fact, when it started to print money, the Bank of Japan had planned to inject $1.4 trillion into the Japanese financial system by April 2015. This was pretty big, given that the size of the Japanese economy is around $5 trillion. Now it will end up printing even more yen. The size of the balance sheet of the Bank of Japan has gone up rapidly since March 2013, a month before it actually started to print money.
Back then the size of the balance sheet of the Bank of Japan had stood at 164.8 trillion yen. Since then it has jumped
to 276.2 trillion yen as of September 2014. This has happened because the Bank of Japan has printed money and pumped it into the financial system by buying bonds.
The question is why has the Bank of Japan decided to increase the quantum of money printing now. The answer lies in the fact that even with all the money printing it hasn’t managed to create the desired 2% inflation even though the inflation in Japan is at 3.4%. But how is that possible? As investment letter writer
John Mauldin explains in a recent column “What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voilà, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1%.”
Given this, the real inflation is at 1%. The Bank of Japan wants to increase it to 2% and hence, has decided to print more money than it did before.
The irony is that Bank of Japan like other central banks in the developed-world before it have, is trying more of a policy which hasn’t worked for it. James Rickards explains this dilemma beautifully in
The Death of Money: “the great dilemma for the Federal Reserve and all central banks that seek to direct their economies out of the new depression [is that] … the more these institutions intervene in markets, the less they know about real economic conditions, and the greater the need to intervene.”
This move by the Bank of Japan also means that the era of “easy money” will continue. More money will now be borrowed in yen and make its way into financial markets all over the world. In fact, the Indian stock market has already started partying with the Sensex rallying by 519.5 points or 1.9% and closing at 27,865.83 points on Friday.
And this is the irony of our times. The stock markets treat bad economic news as good news because the investors know that this will lead to central banks printing more money as they try and get economic growth going again.
As Gary Dorsch, Editor, Global Money Trends newsletter, wrote in a recent column “Bad economic news is treated as Bullish news for the stock market, because it lead to expectation of more “quantitative easing.” Quantitative easing is the term economists use for central banks printing money and pumping it into the financial system by buying bonds. This is precisely what is happening in Japan.
As Dorsch further points out “And the easy money flows that are injected by central banks go right past goods and services (ie; the real economy) and are whisked into the financial markets, where it pushes up the prices of stocks and bonds. In simple terms, what matters most to the stock markets are the easy money injections from the central banks, and to a lesser extent, the profits of the companies whose stocks they are buying and selling.”
To conclude, this is not the last that we have seen of a developed-world central bank deciding to print more money to create some inflation. There is more to come.
Stay tuned.

The article originally appeared on www.FirstBiz.com on Nov 1, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)