On Friday morning in Tokyo, the Nikkei stock index was up again, at 20,600, highest in 15 years. Since “Abenomics” has become a common word in December 2012, the Nikkei has soared 128% on a crummy economy, terrible government deficits, and an insurmountable mountain of government debt. This 10-day run of straight gains, or 11-day run if Friday plays out, is the longest glory streak since February 1988 when Japan was in one of the craziest bubbles the world had ever seen.
The subsequent series of crashes had the net effect that the Bank of Japan became engaged in propping up the stock market not only by pushing interest rates to zero and dousing the market with money via waves of QE, but also by buying equity ETFs and J-REITs.
Prime Minister Shinzo Abe has made asset-price inflation his top priority. Under pressure from the BOJ and the government, state-controlled entities – such as the Government Pension Investment Fund with ¥137 trillion in assets – are dumping Japanese Government Bonds into the lap of the BOJ and are buying stocks with the proceeds.
Foreign hedge funds have jumped into the fray, which is the hot money that can evaporate overnight. But fear not, every time the Nikkei drops 100 points or so, the BOJ starts buying, or creates the perception that it’s buying, and within minutes, stocks shoot back up. It’s part of the BOJ’s relentlessly communicated policy to inflate asset prices come hell or high water.
And hell or high water may now be on the way.
Ultimately, monetary policies hit the currency. So the yen has sagged about 35% since Abe took over. On Thursday in Tokyo, it hit ¥124.3 to the dollar, the lowest since December 2002. Friday morning, after some jawboning by the government and the BOJ, it recovered a smidgen.
This is still on the BOJ’s wish list. But with a limit. Major Japanese companies, such as Sony, are already complaining: they’ve been offshoring production, and now their products have to be imported into Japan, but the yen makes imports very expensive. Raw material importers are complaining. Energy users are complaining. It’s the worst sort of inflation.
But the yen has done wonders for Japanese investments overseas and for Japanese multinationals. They’re converting overseas profits into sagging yen. These paper profits are hoped to stimulate more feverish buying in the stock market. Sort of an endless loop: the lower the yen, the higher the paper profit, until the yen approaches zero and profit infinity, or something.
This is what started to happen last fall to the Russian ruble. When it happens slowly, central banks welcome it as part of their currency war. But if it happens rapidly, it causes all kinds of economic mayhem. Wealth destruction hits coddled investor classes and corporations, and this must be stopped.
The Russian central bank jacked up its benchmark interest rate to 17% and sold large amounts of dollars and euros and bought rubles with the proceeds. It stopped the ruble crash!
The central bank did because it could. Unlike the Japanese government, the Russian government isn’t drowning in debt. Much of the nation’s debt is held by state-owned corporations that could borrow cheaply in dollars and euros overseas, at least until the sanctions set in. And the government has oil and gas revenues, though they’re lower than they used to be.
Japan can’t do any of this to stop a sudden plunge in the yen.
The BOJ cannot raise its benchmark interest rate to 17% or 10% or even 2%. It would bankrupt the country instantly. The BOJ must keep even long-term rates near zero.
And it cannot sell its ample foreign exchange reserves and buy yen with the proceeds because it would be a total and instant reversal of QE! Instead of buying assets and handing out yen, it would have to do the opposite without warning, in one fell swoop. It would have to abandon QE and at the same time buy back the yen it had until then dumped into the market.
Asset prices – its carefully constructed house of cards – would crash unceremoniously. Interest rates would soar across the spectrum. Much of Japan’s paper “wealth” would go up in smoke. And the government, which borrows nearly 50% of its total outlays, could no longer borrow. It would be reduced to where Greece is today. Only worse.
And that will never be allowed to happen. So the BOJ can’t do what Russia did. It can only jawbone the markets. It can talk of the yen-selling being “overdone.” It can regret the “rapid decline.” It can say that “excessive exchange-rate volatility is undesirable,” as a government spokesman just phrased it.
Jawboning works. Until it doesn’t. At some point, the markets want to see action. They want to see someone else buy yen. But the BOJ can’t be that buyer. It can only jawbone.
To keep the nation from descending to where Greece is, the BOJ will keep its iron fist on the government bond market. It will keep interest rates near zero. It will keep JGB prices inflated. And it will keep the government funded. It will do so by buying JGBs and handing out yen, no matter what.
The rest is secondary – the yen and the stock market, both. So when the yen begins to crash past all jawboning, there might not be much of a floor underneath it.
If Japan is lucky, there won’t be a sudden ruble-like 60% crash in the yen, on top of the 35% swoon it already experienced. Or it may come years down the road when another government is in place and when a different crew runs the BOJ. That’s the plan for those folks today. After us the deluge. But if something nevertheless triggers it in an untimely manner, or if it starts coming unglued on its own, it will get ugly. It will be the mother of all currency debasements.
Some companies are already placing their chips. Apple is planning to issue its first yen-denominated bonds next month to benefit not only from the ultra-low interest rates, but also from a potential yen crash that would wipe out much of the dollar value of these bonds.
Wall Street has already jumped on the opportunity. It has created a special sausage maker: US junk goes in; yen-denominated Triple-A-rated bonds come out. Read… How Wall Street Is Exporting Toxic Junk Loan Waste To Japan
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.