In response to the global financial crash of 2008, monetary authorities in the US, Eurozone, UK, Japan and China have implemented QE plans to purchase massive quantity of bonds to jump start their economies. However, the programmes soon morphed into full-fledged currency wars.
Following the February Shanghai G20 meeting, monetary authorities, under the US auspices decided not to pursue exchange rate depreciation in a beggar-thy-neighbor approach. For a while it appeared that there was a halt in the currency wars. However, with the global slowdown in the first half of 2016 and the Fed's delays in implementing its normalization policy, the market came to the view that the Fed is welcoming a weaker US dollar.
On August 4th, the British pound depreciated further after Governor Carney announced that to mitigate the adverse effects of the Brexit referendum Bank of England would expand its bond purchase substantially and buy not just more government bonds, but also corporate bonds. A few days earlier, on July 29th, the Bank of Japan that has been purchasing about 80 to 120 trillion yen (close to $1 trillion) of government bonds each year, announced that it would increase the scale of a program to buy exchange-traded stock funds to ¥6 trillion a year from ¥3.3 trillion, and it doubled the size of a dollar-denominated lending program aimed at Japanese companies operating overseas to $12 billion. However, the yen jumped 1.8 percent to 103.37 per dollar. We may recall that on May 22nd, while denying that he is targeting exchange rate value of yen, the bank’s governor, Haruhiko Kuroda, had said :
"If necessary, we can further ease our monetary conditions in three dimensions. Quantitative, qualitative and interest rates."It would be interesting to ask if the Japanese policy review in September will result in the resumption of currency wars and will the helicopter money help UK and Japan to improve their economic outlook amidst of the current global slowdown?
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| Japanese Yen -US Dollar Exchange Rate |
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| British Pound - US Dollar Exchange Rate |
In UK, the Bank of England, introduced its programme under the banner of "exceptional package of measures" amidst of the current global slowdown. This move was taken by many as the signal that the Bank will do what is required for "monetary and financial stability". The package included:
* a cut in the UK policy rate from 0.5% to 0.25%,As a consequence bond yields have plummeted in the UK, for instance the yield on its longest-dated bond, the 2068 maturity, has declined from 2% on the day of the referendum to 1.06% on August 11, but any marked impact on GDP is highly doubtful. In the belief that the QE policy will lower interest rates and encourage investment and consumption of interest sensitive durable goods, thus boosting the GDP growth, the Bank has been buying bonds (gilt) at auctions in the market since 2009.
* a quasi-forward-looking guidance that interest rates could go lower (to near zero) by the year end, and
* a plan to buy £60bn worth of government bonds, extending the existing quantitative easing (QE) programme to £435bn in total, and £10bn of corporate bonds over an 18-month programme set to start mid-September in a bid “to impart broad economic stimulus”. Targeted companies would be those conducting “genuine business in the UK”, and not banks, building societies or insurers.
We have of course discussed in the past the dangers of negative interest rates, the adverse impacts of lower rates on savers and borrowers at such high level of debts, anemic productivity growth, widening of current account deficit and lack of capital formation; and thus will not dwell any further on these issues here. Suffice to remind readers that a year ago we had predicted the lower British economy's growth, which we attributed to these fundamental factors particularly a lack of productivity enhancing investment. We now notice that the Bank has revised down its growth forecasts for 2017 from the 2.3%, expected in May, to 0.8%, in its recent announcement.
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| Bank of England's holdings of bonds (gilt), Source: Bank of England |
Although, the British pound has been depreciating since the mid-2014 and the Brexit has given a boost to its decline, the bank's declared the new package's main aim was to mitigate the prevailing uncertainty. In the words of Governor Mark Carney:
"By acting early and comprehensively, the (Bank) can reduce uncertainty, bolster confidence, blunt the slowdown and support the necessary adjustments in the UK economy,"The Governor, however, acknowledged that when rates are so close to zero the effectiveness of any further cuts on the economy would be diminished, thus restraining the impacts of interest rate cuts and quantitative easing.
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| UK's Labour Productivity, (pre-crisis peak=100) |
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| UK Manufacturing Input Price Inflation, Annual Rate, Source: ONS |
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| UK Unemployment Rate (Age 16 and over), SA |
The Governor's warning was an important one, to the effect that a week later on August 10th when the bank tried to purchase its targeted £1.17bn of bonds it could not find enough sellers for a shortfall of £52m. This excess demand for bonds raised their prices and thus lowered their returns. In fact, yields on UK government bonds on 3 and 4 year turned negative (to minus 0.017 and minus 0.015 percent respectively).
Despite the fact that the £52m excess demand for bonds was relatively a small sum, and the fact that the Bank assured the market that it will make up the shortfall in the second half of its six-month purchase programme, the signal indicated that investors, seeing the low British productivity growth and the current global output gap, were trying to hold on to their relatively safe higher-return bonds, particularly when interest rates are expected to fall in this uncertain times.
In short, savers increasingly worrying about their future earnings are trying to save more.This implies that the future shortfall in supply may need to be eliminated by the Bank's direct purchase of government bonds -- i.e, by helicopter money.
The new Chancellor of the Exchequer Philip Hammond may be using helicopter money to both prop up consumer demand and finance government's infrastructural projects. He has abandoned plan to deliver a budget surplus by 2020 and has said "We have the option of a fiscal response," and he will be using the autumn statement,“to keep the economy on track.”
However in uncertain times helicopter money is a dangerous tool, particularly when the monetary authority's credibility is under a heavy scrutiny. Given that the Bank will be directly financing the infrastructural projects of the governing party, which depending on various electoral strategies are usually concentrated in certain constituencies under a political agenda, it will politicize the Bank -- which is supposed to be an apolitical entity. The politicization could, most probably, destabilize the economy, because it destroys the price discovery mechanism of the market, generating the risk of stagflation in the current challenging circumstances.
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| UK's Current Balances ( four-quarters cumulative) as a percentage of GDP |
In Japan, with its aging demography, and a population that has been declining since 2008, the Bank of Japan's stimulative bond purchasing policies has been totally ineffective in generating growth. Moreover the adverse effects of negative interest rates have already distorted the Japanese financial market. For instance, as a result of lack of interest on a sale of 10-year Japanese government bond its yield has raised to 0.053 percent`from a negative 0.13 percent.
The distorted financial market in an economy with a declining population, where Japan's fertility rate at 1.6 children is well below its replacement level of 2.1, can prolong the prevailing uncertainty. The situation is exacerbated by the fact that more than a third of the population is older than 60, with a high marginal propensity to save.
Although Japan’s economy appears to have reached full employment at the unemployment rate of 3.1 per cent in June, there are indications that, like in the US and Europe, businesses are adopting intensive-margin production strategies and postponing irreversible capital formation. This is why Japan’s economy has been fluctuating between expansions and contractions in recent quarters, has a stagnating wage growth and its businesses are hoarding cash that has reached the staggering level of US$3.4 trillion.
In these conditions, exacerbated by the adverse effects of the global slowdown the Japanese policy makers are trying to introduce a coordinated policy move with the Bank of Japan almost doubling its purchases of exchange traded funds (which include real-estate investment trusts, corporate bonds, commercial paper and stocks) and the Japanese government introducing a fiscal stimulus package at a total value of ¥28 trillion ($273 billion) over several years, that includes ¥7.5 trillion in new spending to jump-start the country's sluggish economy.
The intensified uncertainty, emanating from the negative interest rate policy and the Bank of Japan's announcement of an upcoming assessment of the effectiveness of its current stimulus policies in September has triggered a further appreciation of yen and a sell-off in the Tokyo stock market, as well as the worst sell-off in government bonds in more than three years, that has already impacted other countries bond markets.
Japan's economy grew by an annualized 0.2 percent in the second quarter (0.2 percent on a quarter-on-quarter basis), well below the 0.7 percent increase markets had expected and a marked slowdown from a revised 2.0 percent increase in January-March. Household consumption, constituting about 60 percent of GDP, rose 0.2 percent, slowing from a 0.7 percent increase in the previous quarter, and capital expenditure declined 0.4 percent after a 0.7 percent drop in the first quarter.
The September policy review may be a prelude to Japan's deployment of helicopter money in the currency wars, particularly if the Fed continues to delay its policy normalization.
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| Japan's GDP Growth Rate, Quarterly- Seasonally Adjusted |
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| Japanese Government 30-Year Bond Yield |
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