“If you wish to destroy a nation you must first corrupt its currency. Thus sound money must be the first bastion of a society’s defence.†– Adam Ferguson (Historian)
The Yen is crashing again. This is extremely bullish, we are told, because of a novel economic theory that has taken hold. The theory goes as follows:
1) Japan announces yet another unprecedented measure to crash their currency.
2) The market buys the news, the Nikkei explodes higher, pushing up other global markets in sympathy.
3) Since short-term stock price movements are never wrong, this must be good policy.
While I’m prone to hyperbole at times, the above theory is not far off from the truth. If you turned on financial television last Friday, this is precisely what you heard. You heard nothing about whether the policy is fundamentally sound and everything about how the day’s stock market gains were validation that the policy was to be lauded.
(Note: Importantly, you also likely heard nothing about how intermarket action was not confirming the belief that this latest initiative was likely to stimulate inflation expectations, with defensive sectors and long duration Treasuries continuing to lead after the announcement. At Pension Partners, we remain defensively positioned in our mutual funds and separate accounts.)
But is Japan really rewriting economic theory? Should we simply accept the prevailing notion that crashing your currency is bullish for all because stock prices are higher? Perhaps, but the story is here is far from that simple.
Debasing Your Way to Prosperity
First, history has not been kind to countries attempting to debase their way to prosperity. If it were an effective means to grow your wealth, Zimbabwe would be the world’s richest. A little devaluation may be a good thing as a short-term boost to exports, but a massive devaluation is an entirely different situation.
What the Bank of Japan is attempting to do here is just that and beyond unprecedented. They already had the largest quantitative easing program in existence with central bank assets at over 57% of GDP (see chart below). But this level apparently was not good enough and they upped the ante to 80 trillion yen per year (from 60-70 trillion) with an increase in direct purchases of equities through exchange-traded funds (ETFs).
