Sensex hits record high: Now Japan takes over the easy money party from the US

Two days after the Federal Reserve of the United States brought to an end its money printing programme, the Bank of Japan decided to do exactly the opposite. In a surprise move the Japanese central bank on Friday (October 30, 2014) decided to increase the amount of money it has been printing to get the Japanese economy up and running again.

The Bank of Japan will now print 80 trillion yen (or around $727 billion) per year. The central bank has been printing money since April 2013 and was earlier targeting around 60-70 trillion per year. It pumped this money into the financial market by buying Japanese bonds.

In fact, the Bank of Japan entered the money printing party rather late. The money printing efforts of the Japanese central bank in the aftermath of the financial crisis were rather subdued and it had expanded its balance sheet (by printing yen and buying bonds) by only 30% up to December 2012. And then things changed.

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This was after Shinzo Abe took over as the Prime Minister of the country on December 26, 2012. He promised to end Japan’s more than two decades old recession through some old-fashioned economics, which has since been termed as Abenomics.

Abenomics is nothing but money printing in the hope of creating some inflation. Abe’s plan was to get the Bank of Japan to go in for money printing and use the newly created “yen” to buy Japanese bonds.

By buying bonds, the central bank ended up pumping the printed money into the Japanese financial system. The hope was that all this extra money in the financial system would lead to lower interest rates. At lower interest rates people would borrow and spend more, and in the process the government would manage to create some inflation, as more money would chase the same amount of goods and services.

The Bank of Japan, the Japanese central bank, went with the government on this and is targeting an inflation of 2 percent. It wants to reach the goal at the earliest possible date, by printing as much money as maybe required.

And how will that help? In December 2012, Japan had an inflation rate of -0.1 percent. For 2012, on the whole, inflation was at 0 percent, which meant that prices did not rise at all. In fact, for each of the years in the period 2009-11, prices had fallen in Japan.

When prices are flat, or are falling, or are expected to fall, consumers generally tend to postpone consumption (i.e., buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses, as their earnings either remain flat or fall. This slows down economic growth.

On the other hand, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So, by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decades old recession.

In fact, when it started to print money, the Bank of Japan had planned to inject $1.4 trillion into the Japanese financial system by April 2015. This was pretty big, given that the size of the Japanese economy is around $5 trillion. Now it will end up printing even more yen. The size of the balance sheet of the Bank of Japan has gone up rapidly since March 2013, a month before it actually started to print money.

Back then the size of the balance sheet of the Bank of Japan had stood at 164.8 trillion yen. Since then it has jumped to 276.2 trillion yen as of September 2014. This has happened because the Bank of Japan has printed money and pumped it into the financial system by buying bonds.

The question is why has the Bank of Japan decided to increase the quantum of money printing now. The answer lies in the fact that even with all the money printing it hasn’t managed to create the desired 2% inflation even though the inflation in Japan is at 3.4%. But how is that possible? As investment letter writer John Mauldin explains in a recent column “What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voil, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1%.”

Given this, the real inflation is at 1%. The Bank of Japan wants to increase it to 2% and hence, has decided to print more money than it did before.

The irony is that Bank of Japan like other central banks in the developed-world before it have, is trying more of a policy which hasn’t worked for it. James Rickards explains this dilemma beautifully in The Death of Money: “the great dilemma for the Federal Reserve and all central banks that seek to direct their economies out of the new depression [is that] … the more these institutions intervene in markets, the less they know about real economic conditions, and the greater the need to intervene.”

This move by the Bank of Japan also means that the era of “easy money” will continue. More money will now be borrowed in the yen and make its way into financial markets all over the world. In fact, the Indian stock market has already started partying with the Sensex rallying by 519.5 points or 1.9% and closing at 27,865.83 points on Friday.

And this is the irony of our times. The stock markets treat bad economic news as good news because the investors know that this will lead to central banks printing more money as they try and get economic growth going again.

As Gary Dorsch, Editor, Global Money Trends newsletter, wrote in a recent column “Bad economic news is treated as Bullish news for the stock market, because it lead to expectation of more “quantitative easing.”

Quantitative easing is the term economists use for central banks printing money and pumping it into the financial system by buying bonds. This is precisely what is happening in Japan.

As Dorsch further points out “And the easy money flows that are injected by central banks go right past goods and services (ie; the real economy) and are whisked into the financial markets, where it pushes up the prices of stocks and bonds. In simple terms, what matters most to the stock markets are the easy money injections from the central banks, and to a lesser extent, the profits of the companies whose stocks they are buying and selling.”

To conclude, this is not the last that we have seen of a developed-world central bank deciding to print more money to create some inflation. There is more to come.

Stay tuned.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)