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The view from Nihonbashi…

Imagine that you are sitting in your office at the Bank of Japan building in Nihonbashi, Tokyo … you’re clicking through the news stories on your Bloomberg terminal and you come across the following about American consumers: 

~~~~ ” ….Retailers, which started offering discounts of 50 percent or more weeks ago, had been counting on post – Christmas sales to help rescue what will probably be the worst holiday season in four decades. That’s not going to happen, said Burt Flickinger, managing director of Strategic Resource Group, a retail-industry consulting firm in New York.

“This week isn’t going to do it,” Flickinger said in a Bloomberg Television interview. “Consumers are more cash- and credit-constrained than ever before. After a 25-year spending tsunami, they’ve shifted from spending to savings.” ~~~~

Uhmmm… you think… American consumers are shifting to savings … this will have implications for Japanese and US monetary policy… significant ramifications…  you consider the actions of your central banking counterparts at the  Federal Reserve who have begun engaging in “quantitative easing (QE)” like the Bank of Japan did between 2001 and 2005…  

~~~~ ” … The Bank of Japan is the only major central bank in modern times to rely on quantitative easing — the strategy of injecting more reserves into the banking system than needed to keep the target interest rate at zero.

Steps Bernanke has taken so far have prompted some Fed officials and economists to say the central bank is already pursuing such a policy. With an array of emergency-loan programs aimed at easing the worst credit crisis in seven decades, Bernanke has expanded the Fed’s balance sheet to $2.11 trillion as of last week, more than double the year-earlier level…

… Bank of Japan Governor Masaaki Shirakawa said in May that while the strategy “was very effective in stabilizing financial markets,” it had “limited impact” in remedying Japan’s economic stagnation because banks wouldn’t lend and companies wouldn’t borrow…. ” ~~~~


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A nice primer on Quantitative Easing

Quantitative easing from Marketplace on Vimeo.

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Now many beyond the precincts of Nihonbashi,  Threadneedle and Liberty Streets have broader visions for the role of the central banks in restarting the various frozen economies … from the Economists Forum blog via Libertarian Democrat Point of View …

This passage describes the Federal Reserve purchasing US Treasuries to push down Treasury yields in an effort to force banks to lend instead of buying Treasuries to capture the yield spread …

The authors are arguing that the Federal Reserve extend this practice beyond the debt of the national government to the debt of private corporations… this would represent a massive intrusion into the economy on the part of the Federal Reserve… the authors argue… 

~~~~ ” … Quantitative easing will be much more effective if the central bank uses its balance sheet to buy not government bonds but better quality illiquid and undervalued structured and mortgage-backed securities. This eases bank funding constraints and so directly expands the stock of credit.

Moreover, as the economy recovers, credit spreads will fall and so the central bank can make a profit. 

Quantitative easing will be more powerful still if the central bank takes pure credit spread exposures, using interest rate swaps to remove its exposure to fluctuations in nominal interest rates.

It can also conduct equivalent synthetic transactions, purchasing government bonds alongside an interest rate swap and the acquisition of negative net worth credit default swaps. Unlike a private sector participant, as the monopoly supplier of outside money it can always meet margin calls and so cannot be squeezed out of credit default swap trades.

Finally, to guide expectations, it should set forward targets for credit spreads.

Perhaps the clearest way to present this point is to put the question in another way: what is the most appropriate alternative instrument of monetary policy, during the period when money market interest rates are reduced to their zero floor?

Aggregate bank reserves or money stock are poor choices, since in present circumstances they can increase by huge amounts without impacting credit or expenditure. A better choice is market credit spreads. The Bank of England’s monetary policy committee can use its regular meetings to announce its preferred levels for average market credit spreads. Bank monetary operations can enforce this decision.

By setting credit spreads at appropriate levels the bank will put a floor under market values, restore credit market liquidity and economic activity and make a handsome profit to boot.” ~~~~


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Back to Nihonbashi… after pouring your second cup of tea for the morning you pull out the most recent Bank of International Settlements quarterly report… you are trying to remember the relative scale of open market operations during the credit market panic of 2008… the Federal Reserve, the European Central Bank and the Bank of England have all conducted operations and lent in significant volume… see below… 

This means that central banks have inserted “significant liquidity” into the global financial system… “significant liquidity”

Sipping your tea you wonder … how much of this “significant liquidity” will be funnelled into a carry trade?

The carry trade definition

~~~~ ” A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage the investor chooses to use.” ~~~~

Yields on 10 year Japanese government bonds are now around 1.20%… you see the reversal of the yen carry trade happening… yes … making monetary policy with the new activities of Federal Reserve Chairman Bernanke will be complex… all the old patterns are breaking down… 

~~~~ ” … By early year 2007, it was estimated that some US$1 trillion may be staked on the yen carry trade. Since the late-1980’s, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies. Many of these activities included matters like subprime lending in the USA, yet also include funding of emerging markets especially BRIC countries and resource rich countries.

According to Gary Dorsch of Global Money Trends, the yen carry is a “weapon of mass destruction” of $5.9 trillion, with yen loans another 1.2 trillion dollars on top of it, making Arabian oil wealth or Chinese reserves look small at $1.5 trillion and $1.9 trillion respectively.” ~~~~


BIS Charts via the Capital Spectator

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