Saturday, November 1, 2014

Japan's Monetary Stimulus -- Good News?

World stock markets surged last week on the news that Japan was putting in place it's own version of the Bernanke QE (quantitative easing) policy.  What is QE?

QE is a central banking policy that involves creating (out of nothing) currency and then using that (digitally created) currency to purchase bonds (usually, mostly government bonds or government-backed bonds).  On the face of it, this policy seems pointless, other than possibly reducing the value of one's currency and expanding the amount of government debt by providing the government itself as a buyer.

So, what is the point, according to those who believe in QE?  To true believers, QE provides needed liquidity to a weak economy and keeps interest rates much lower than they would be. In other words, QE is seen as a stimulus to the economy by QE supporters, through there is no empirical evidence whatsoever that QE does what it supporters claim.

Interest rates during the 10 years of the Great Depression (1929-1939) were rock bottom, with treasury rates never exceeding 1/4 of one percent for the entire decade.  Where was QE when this was going on?  The answer is that there was no QE at all during this period.  Rates were low for reasons unrelated to Fed policy, which is probably also the case today.

QE basically enables higher levels of government debt that sets the stage for massive inflation once private lending takes off, dramatically expanding the money supply.  It works like a toxic and fatal drug that, for a while, eases the pain.

So, what's the deal with Japan.  Japan is the world's third largest economy after China and the US with a per capita income of almost $ 50,000.  But Japan has two major problems: (i) too much sovereign (government) debt -- over $ 10 trillion and more than twice its GDP; (ii) moribund economic growth.

So, what to do?  QE simply expands the ability of Japan to raise its debt levels, while doing absolutely nothing about Japan's moribund economic growth.   In other words, the answer to the problem of too much debt is to increase the amount of debt.  That's the answer that the Eurozone has stumbled upon.

When the momentary euphoria fades, reality will set in.  QE policies only make things worse.

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