Tuesday, December 30, 2014

8 to 12 trillion new Yen per month? Stick a fork in it.


On Dec 30th the Bank of Japan announced that it will start making 8 to 12 trillion new Yen per month.  To get an idea of the scale of this, the Government of Japan averages less than 5 trillion per month in taxes collected.

On Apr 4th 2013 the BOJ announced it would double the monetary base in 2 years.      This came to around 50-70 trillion Yen per year for 2 years.  The monetary base seemed to go up about 0.6% every 10 days.

However, as we started to near the end of the 2 year time period a new policy was  announced on Oct 31st of 80 trillion Yen per year with no end date.   This was 10 to 30 trillion Yen per year more than previously.  The monetary base seemed to go up around 1% every 10 days.

If the Dec 30th rate stays fixed for the whole year, then multiplying by 12 gives a new yearly target of 96 to 144 trillion Yen.  After the initial 2 year period is over, in Apr 2015, instead of stopping it now seems they will be printing about twice as fast.  The monetary base should go up well over 1% every 10 days.

However, one familiar with how these things work, or able to spot a trend, should not expect a fixed 8 to 12 trillion Yen per month for the whole year but instead to see more increases in the rate of Yen printing.  If you did not spot the trend, read the previous 3 paragraphs again.  :-)

Thursday, December 25, 2014

No, Japan Cannot Stop Printing Yen


The official story is that Japan is printing like crazy just because they want more inflation and that they will stop when they get to 2% inflation.   The story makes it seems like the government and central bank have things under control.   Like they are making the markets do what they want.   The vast majority of articles I read on the net seem to accept this official story as truth, but it is not true.

With 5 year bonds paying 0.03% interest, the rational investors are getting out of JGBs.   The central bank is probably the only net buyer.  The central bank is making about 80 trillion new Yen per year and buying bonds when total taxes collected are about 50 trillion yen per year.  This is an enormous amount of new money.

They have been increasing the base money supply by around 1% every 10 day reporting period.  You have to be a fool to buy bonds paying 0.03% interest per year in a currency where the base money supply is going up around 1% every 10 days.

If we average over the last 4 months, the Yen is losing around 1% per week compared to the dollar.  You have to be a fool to buy a 5 year bond paying 0.03% interest in a currency losing about 1% per week.

The Japanese government is spending about twice what they get in taxes.    Nobody likes spending cuts and nobody likes tax increases.  Not enough voters or politicians will view this as a problem as long as they can print money for the difference.   You have to be a fool to buy bonds in a country that spending twice what they get in taxes and running the printing presses to cover the difference.

However, if they let interest rates go up in an attempt to attract bond buyers the interest on the debt would be more than the taxes collected.   This makes it clear they are going to have to print money and so the money that you get back when the bond comes due will not be worth as much as the money you bought the bond with.  You would have to be a fool to buy bonds from a government where the interest on their debt was more than their total taxes.

Not only do you have to be a fool to buy JGBs, you have to be a fool to hold them or roll them over.   So not only do they have to print Yen to cover the deficit, but also the bonds coming due.   The government has previously issued bonds more than twice the total GNP and much of it is short term.  As it comes due they have to pay the bond holders.   The only way they can get money to pay previous bonds is by first selling a new bond, since taxes don't even cover spending.  The only way they can sell a new bond is if the central bank prints Yen and buys the bond.   Governments never default on debts in a currency they can print.  They print.

Japan has entered a death spiral where the more people that get out of JGBs the more Yen they have to print but the more Yen they print, the more people get out of JGBs.  This death spiral is a positive feedback loop that once started is very hard to stop.

Recently Krugman got in a limo with Abe and advised him to delay a tax increase and do more money printing (he would really have said "stimulus").  Krugman may soon wish he had not gotten his name attached to the mess that is coming.

Even at 120 Yen per dollar, we are talking trillions of dollars worth of bonds.   Fools with money will hardly make a dent in this.   The central bank will keep being the buyer of only resort.  The central bank must keep printing no matter if it lets interest rates go up or if they keep interest rates down.    They have past the point of no return.  They can not stop at 2% inflation.  Yen printing is out of control.   It is no longer possible to halt it.   

Saturday, December 20, 2014

Payment for Additional Hyperinflation Explanations


I count 49 different explanations for hyperinflation in my collection as of Sat Dec 20th, 2014.

I think it is fun that there are so many different, yet reasonably, ways of thinking about how hyperinflation works.   Given how many I have found so far, I am sure there must be more good explanations out there.  If there are other economic theories with different explanations for hyperinflation I would really like to add them to my collection.

I have decided I will pay $30 by paypal or BitCoin to someone who comments here with a new explanation that in my judgement is different from any in the existing collection but is as good or better than the average explanation so far.   It should fit the experimental evidence for at least many historical hyperinflations.

I am not looking for different reasons that governments spend more than they get in taxes and will not pay for such things.  Saying "supply shock", "war", "corruption", "external debt",  "drop in taxes", "incompetence", "madness", etc does not earn anything. 

I am looking for more good theory for the mechanics of how hyperinflation works.  The why, the how, the process of hyperinflation.    See existing explanations for an idea of the type of thing I am looking for and to be sure you are not submitting something already in my collection.

Please forward this offer to anyone you think might be willing and able to submit an explanation.

This offer starts today, Dec 20, 2014.    I can afford at least 10 new explanations and even 5 good explanations every month.  I may reduce this offer for future submissions if they come much faster than that.  If I don't get many I may up the offer and if so the increase in payment will also be retroactively extended to previous winners.    

To submit an explanation just comment below.   The full explanation must be in the comment but it is good to also include a link to a source if you have one.

Wednesday, December 17, 2014

This is Not Natural

For the last 3 months the Yen is losing on average around 1% per week:


Yet the yield on 2 year Japanese Government Bonds (JGBs) is negative.  You have to pay the government to take your money.   The 5 year yield is 0.05%.   This means after 5 years you get a total of about 0.25% interest.   This is about what the Yen loses in the average day recently.


They are printing at a rate of 80 trillion yen per year and buying mostly JGBs, much more than the total taxes collected.   This has driven up JGB prices far into bubble territory.  These yields are absolutely nuts.  It is not natural.   Only massive central bank money creation and bond buying makes these kinds of numbers possible.   These are not free market rates.  Sane people are not buying JGBs at these yields with the value of the Yen falling fast.   The insane central bank must be the only buyer.

 Bubbles always fail somehow.   Since the Japanese government could not afford rational interest rates on their debt, I expect the central bank to keep interest rates down.   However, to do this they have to make new Yen so fast that they will destroy the currency.

Saturday, November 8, 2014

Greenspan on Inflation and Gold


Interesting recent interview with Greenspan.  Some parts:

But the fact the fiat currency expansion got very tarnished with -- you know, in 1775, we printed a whole bushel full of continentals. And one of the fascinating things about that period is the fact, for the first year or two, there was very little evidence that that had any effect on prices, meaning that that paper currency circulated with the same value as specie.

And there is an extraordinary -- there's an extraordinary lag which exists between actions of that type and consequences. Now, eventually the continental was not worth a continental. But it took a long while. And I think that we're looking at very similar things now. This, again, is a human propensity.

The Continental currency had hyperinflation.   It is interesting that Greenspan says, "I think that we're looking at very similar things now".   He is directly talking about the long delay between printing money and high inflation, but it sure seems like he is hinting at high inflation this time too.

Greenspan also thinks gold is a good investment:


Tett: Do you think that gold is currently a good investment?

Greenspan: Yes... Remember what we're looking at. Gold is a currency. It is still, by all evidence, a premier currency. No fiat currency, including the dollar, can match it.


First Exchange Rate Drops Then Hyperinflation


In Weimar Germany the exchange rate adjusted well before inflation started.


In Zimbabwe the exchange rate collapsed 72% on November 14 1997.  After that inflation really started picking up.

I believe the normal case for hyperinflation is that the exchange rate drops first and then the inflation picks up after.  The exchange rate reacts quickly while the huge number of prices that make up inflation indexes take longer to adjust.


I expect that Japan will see the Yen exchange rate drop much more before they start getting high inflation.






Wednesday, November 5, 2014

2.6% in 11 days

From Oct 20 to Oct 31 the Central Bank of Japan increased their balance sheet and the base money supply by 2.6%.   The last day of this period was their big announcement that they would be making 80 trillion yen per year.   I wonder if the current 10 day period will be even higher, since all of these days will be after the big announcement.  Will be very interesting to see the next report.

I don't expect the demand for Yen is going up as fast as the supply.  In fact, with all this printing I would expect the demand to go down.

Saturday, November 1, 2014

Impending Shortage of JGB Fools


As a central bank drives up bond prices investors can make money holding bonds, even at low interest rates.  However, at some point the prices get so high and interest rates so low that you really need a greater fool to buy them.  Currently the interest on 10 year JGBs is less than 0.5% per year.  The Yen was down more than 3% for part of the day yesterday and closed down 2.7%.   It takes 6 years of interest at 0.5% to make up for a 3% loss in the currency.  However, there will be many more losses over the next 6 years, so investors will never catch up.  At this time there is no greater fool than someone holding 10 year JGBs, except someone holding 30 year JGBs.  There will soon be an acute shortage of these JGB fools. 

The normal method to get more people to hold bonds in a currency is for the central bank to let interest rates go up.  This past week Russia let interest rates go up to try to make holding their bonds more attractive to the market.

However, Japan is in such a bad situation that this normal method will not work.  The government is spending about twice what they get in taxes, a problem almost impossible to fix.    The yearly taxes were 47 trillion Yen and the central bank is now monetizing at a rate of 80 trillion per year.   The total Japanese government debt is over 1 quadrillion yen (1000 trillion yen).  Money printing is much more than taxes and more than the deficit.  The central bank is effectively funding the deficit and about that much again buying up bonds from the rest of the market, which on net is reducing bond holdings.   Even the pension funds are now getting out of JGBs.  The Japanese government debt is so high that if interest rates go up to about 4.7%, just paying the interest on the debt will use up all the money collected from taxes.  Rates in Japan were this high in 1991.  If people don't want to buy JGBs now, they won't want to buy them when all of government taxes just cover the interest on the debt.  This is not an attractive situation to bond holders.   Half this rate would mean half of taxes just to pay interest, twice this rate would mean interest twice taxes.  Neither of these is attractive to bond investors either.    The normal method of raising interest rates to improve demand for bonds will not work for JGBs.  There is no interest rate that increases demand so the central bank is not forced to monetize even more than the total deficit at this point.  This is a big problem, the central bank is effectively forced to print money with no way out.

When the central bank of Japan announced the increased rate of monetization they claimed it was because they are worried that lower oil prices are pushing Japan toward deflation, so they want to push harder toward inflation.   I think the real reason is nobody else is buying JGBs and people are selling, so the central bank needs to buy even faster.  Also, when they announced the first huge printing it was to double the money supply in 2 years.  This had the implication that they would stop.  Now they are saying they are printing at a rate of 80 trillion yen per year, which does not imply any ending.

At this point the Japanese Central Bank is really funding Japan's government deficit, with no way to stop.   I think the market is starting to realize this and that is why people are starting to flee JGBs.     Soon, if not already, there will be a death spiral where the more the central bank monetizes, the less people want to hold JGBs and the less people hold JGBs the more the central bank is forced to monetize.  The only alternative is for the central bank to let the government fail, which never happens.    This death spiral has many characteristics in common with positive feedback loops in nature, which tend to end in destruction.  In this positive feedback loop, which also include higher velocity of money and loss of confidence, the end is  the destruction of the currency.   

Keynesians live in fear of a deflationary spiral, which in practice almost never happens and when it does is usually slight.  They are now acting like anything less than 2% inflation is deflation, just so they have some real world examples to panic about. However, they can't seem to imagine or understand a high inflation death spiral, which happens rather often to fiat money and is a much greater danger.  They need to study up on the theory of hyperinflation death spirals.

Mark my words, there will soon be a horrible shortage of JGB fools.

Monday, October 20, 2014

BIS Fears Bond Panic


In a BIS report by Guy Debelle there are warnings of the risk of a bond panic.  A few interesting parts extracted below:

When volatility returns, for a number of reasons, including those I have already mentioned, it may well rise quite rapidly.


But if we look back at previous market sell-offs, when market-making capacity was larger, we see that they were often quite violent too.

There are a few other reasons to suspect that the sell-off, particularly in fixed income, could be relatively violent when it comes.

But there are probably a sizeable number of investors who are presuming they can exit their positions ahead of any sell-off. History tells us that this is generally not a successful strategy.  The exits tend to get jammed unexpectedly and rapidly.

Another reason to suspect that the sell-off might be violent is the starting point, namely zero nominal interest rates. That is a point we haven’t started from before (with the possible exception of Japan).

So there is a fair chance that volatility will feed on itself. One should always be careful of looking for too much rationality in trying to understand market dynamics. Given the lack of rational arguments for the current state of affairs, trying to rationally explain how it will unwind is also going to be difficult. 
So in conclusion, there are a number of anomalies present in financial markets in terms of pricing and volatility. There are also some misplaced perceptions amongst market participants about the degree of liquidity present in some market segments. That strikes me as a dangerous combination and unlikely to be resolved smoothly.
I also think a bond panic will feed on itself.  I think the end result will be that the central bank makes lots of new money and buys up lots of bonds, and the value of the currency goes down.

Saturday, October 4, 2014

Noah says Japan Will Monetize Debt

Noah Smith wrote Japan's Debt Trap where he concludes that Japan will monetize their debt.   On this point I believe he is correct, Japan will monetize their debt.  However, he says a few other things I do not agree with.

Noah:
But if inflation strikes, it could rise high enough to hurt growth, and therefore tax revenue, severely. That would mean game over -- Japan’s government would be forced to default (or to hyperinflate, which amounts to a messier version of the same thing).
Defaulting would not really help because much of the debt is owed to their retired voters.  The government would still end up having to take care of these people, so it would not save that much.  After defaulting the government would still be spending nearly twice what they get in taxes but now the central bank would be the only bond buyer for sure.  With the central bank clearly monetizing their deficit, they would get hyperinflation even after defaulting.  Default in Japan would not avoid hyperinflation.  Yes, hyperinflation amounts to a messier version of default.


Noah:
But I’m not worried. In the end, a sovereign default is just an accounting exercise -- marking down the assets of some Japanese people and marking up the assets of others.

He should be worried.  Hyperinflation destroys an economy.  It is not just an accounting exercise.    I suspect he need to read my CMMT article.

Noah:
The fact is, no one really knows what causes high-inflation episodes to begin.
I really think  I understand and can explain how high inflation episodes work.  In fact, I have a model with which I can simulate how high inflation quickly begins.  It is true that predicting the exact start time of a positive feedback phenomenon is not really possible.  However, we can tell Japan has a high risk of a hyperinflation chain reaction at any time now.