Every week I try to take noteworthy events and provide brief, accessible commentary regarding their potential impacts. Live links to articles are provided for each story. Keep in mind these comments are not necessarily the viewpoint of Newfound Research and solely represent my own personal perspective.
The Bank of Japan (“BOJ”) will seek to aggressively bring Japan out of it’s 20+ year deflationary environment by purchasing approximately $746BB per month in Japanese Government Bonds, ETFs, and REITs. The colossal purchasing spree will double the BOJ balance sheet from 30% to 60% of Japan’s total GDP (for comparison’s sake, the Federal Reserve is at about 25% of US GDP). The execution of this new policy not only shaped the events of this week, but also will have profound impact on investors for the foreseeable future.
Why Should Investors Care? Carmen Reinhart, the Harvard Economist and co-author of “This Time is Different” succinctly phrased it with an interview with Spielgel by saying “money is transferred from borrowers to savers.” The process that will result in savers becoming worse off and borrowers becoming better off is called, “inflating the debt.”
If I own a bond, the principal repayment of that bond doesn’t change when inflation goes up or down (the price may change, but the principal repayment I’m promised at maturity stays constant). However, if I own a business, the revenues (and costs) are impacted by inflation — the inputs to my products would cost more, and I would likely pass on some of that cost to my customers. A similar scenario occurs with a country’s output, and total debt burden. The nominal increase in a country’s output comes from growth in productivity and inflation, whereas the debt of a country remains constant. Even if there is a spike in inflation, interest rates would go up, and would the cost to service the debt, but that’s a budgetary issue and doesn’t directly translate to debt to output ratios.
So Central Banks around the world run by bright economists — dismayed with their political counterparts’ ability to spark growth — are keenly aware of the impacts of high debt ratios, and are therefore doing everything they can to “inflate the debt.” By ncreasing the nominal rate of growth viz inflation, they will thereby lower the total debt burden. That means extremely low interest rates, with eventual higher inflation. In this scenario, savers are penalized and borrowers are rewarded, and that’s what Carmen Reinhart is referring to when she says, “money is transferred from borrowers to savers.”
Look for the move from the BoJ to stoke the flames of real asset values around the world (see the Bitcoin article below) and push all rates even lower (see the article that explains the aging population of Japan and why they are “yield seekers”).
Other Noteworthy Reads of the Week
- Bitcoin Suffered a Massive Decline due to panicked investors concern about the lagged trading time.
- Soros gave a speech in Frankfurt urging Germany to either
- Approve the conversion of government debt stock into Eurobonds or
- Leave the Euro (yes you read that correctly)
- Deflation (finally) took hold in Greece. This process was forecasted to occur 2 years ago according to international forecasters, which shows the impacts of declining GDP while implementing austerity measures (as mentioned by Soros in his above speech).
- The Portuguese constitutional court ruled over the weekend that the benefit cutting for the public sector (one of the requirements put in place for austerity measures) is unconstitutional. This certainly throws a wrench in the austerity plans for the EU, as political risks seem to be the greatest risk on the horizon.
- There has been a growing disparity of financial health between banks in Creditor and Debtor EU states. The Financial Times had a good article that explained the different Debtor issues (Spain’s consumers’ de-leveraging, regardless of rates while Italian borrowers have been passed on rates making borrowing prohibitive). interest rate inelastic of transmitting lower interest rates to consumers.
- The Financial Times and Business Week both had good synopses regarding why Japanese investors are seeking higher yields as BOJ seeks aggressive bond buying in the coming months.