Global Monetary Relief from Asia

The ECB and BOE have shown their intent with their recent aggressive balance sheet expansions and the Fed is trying hard to keep the door open for more QE even as the data in the US continues to defy the general global slowdown.

In Asia however sticky inflation in India, a desire to nail property developers to the wall in China and a belief in a post earthquake recovery in Japan have kept the big Asian central banks from providing additional easing. Even in Australia where the economy has been teetering on the brink of a recession for 6 months, the central bank has refrained from any decisive moves.

In three out of the four cases above however things may slowly be about to change.

In India, the central bank recently opened the door for considerable easing in 2012 as headline inflation comes in. The market has already heavily discounted such a move with Indian equities up about 25% since mid December 2011 and some big ticket single names such as Tata Motors up more than 50%.

Quote Bloomberg

Reserve Bank of India Deputy Governor Subir Gokarn said the monetary authority will cut interest rates once it’s confident inflation will keep slowing.“The stance now is that we have reached the peak and any further action will be toward easing,” Gokarn, 52, said in an interview at his office while discussing the rupee, the government’s budget deficit and bond repurchases. The central bank isn’t concerned about the currency’s record monthly advance in January “because in a sense it’s a correction,” following last year’s 16 percent decline, he said. Emerging-markets have stepped up efforts to shield growth from the impact of Europe’s debt crisis, with Brazil, Russia and the Philippines cutting rates in recent months.

The road is not entirely clear for easing by the RBI where two issues may still derail the central bank’s intention to start an easing cycle.

Firstly, the government’s budget deficit continues to increase and while borrowing to invest in infrastructure etc in India is certainly worthwhile, monetary policy may still have to lean against excessively and essentially structural deficit spending by the government. This is particularly the case as supply side constraints may mean that such deficit spending adds substantially to inflation.

Secondly, the INR may be subject to substantial weakening on a resurgence in global volatility. The Fed’s USD swap lines as well as the the ECB’s efforts to backstop the European banking system have so far calmed things down. Nevertheless, should another period of strong and sudden INR weakness ensue, it means the RBI would not be able to reduce the yield difference to the rest of the world in any meaningful way.

In China, the economy is now visibly slowing. Foreign exchange reserve accumulation have ground to a halt and M1 growth is negative on the year. Even if the desire to cool down excessive credit growth and nailing property developers to the wall might still constitute top priorties, the balance is shifting towards easing.

Quote Bloomberg

China is seen making more cuts to banks’ reserve requirements to fuel lending and sustain economic growth as the housing market cools and Europe’s sovereign-debt crisis weighs on exports.The proportion of cash that lenders must set aside will fall half a percentage point from Feb. 24, the central bank said Feb. 18 on its website. Standard Chartered Plc forecasts at least three more reductions this year, while HSBC Holdings Plc (HSBA) sees a minimum of two.

So far, Chinese authorities seem content to use the reserve requirement ratio (RRR) as the main tool to provide easing. This makes sense in a command market economy where the government can be fairly sure to control the supply side of credit through loan quotas. I think however that the calls for no interest rate cuts until mid 2012 may turn out to be wrong if China is about to slow to the extent that our leading indicators show. Property prices have fallen (or failed to rise) for some time now in China and as growth slows further, the authorities may rightfully begin to argue that their near term objectives have been achieved.

Perhaps the most interesting development this week however came in Japan where the BOJ apparently got my memo as they restarted QE.

Quote Bloomberg

Japan’s central bank unexpectedly added 10 trillion yen ($128 billion) to an asset-purchase program and set an inflation goal after an economic slide fueled criticism it has been slower to act than counterparts.An asset fund increased to 30 trillion yen, with a credit lending program staying at 35 trillion yen, the Bank of Japan said in Tokyo today. The BOJ also said that it will target 1 percent inflation “for the time being.”

This decision appears to have gone completely under the radar, but I think it is very significant. Two points are particularly important to emphasize. Firstly, the entire 10 trillion yen added to the asset purchase program has been earmarked to JGBs which signals the BOJ’s willingness (or the MOF’s orders) that budget deficits in Japan are now to be directly monetised to a much higher degree than has earlier been the case. Secondly, the BOJ has now committed itself to an inflation target (1%) and will use balance sheet expansion to reach this goal.

This is textbook QE and should be bearish for the Yen and bullish for the Nikkei, but things may not be so simple of course. Chris Wood adds to the discussion in the latest version of Greed and Fear [1].

The second point is whether the latest news is a signal to short the yen. On the face of it, it should be. But the issue is whether the BoJ Governor Masaaki Shirakawa is going to follow the previous examples of his conduct of unorthodox monetary policy; whereby he raises thequantity of the so-called asset purchase programme but does not exactly accelerate the pace ofthe buying to fulfil the programme. Thus, the Bank of Japan has so far purchased ¥10.3tn of assets since the latest programme was first announced on 28 October 2010, amounting to only 52% of the previous target of ¥20tn set in October 2011.

In other words, how serious is this inflation target and over what horizon does the BOJ intend to reach it? Only time will tell, but given the persistence of deflation in Japan I would argue that any semi-serious adherence to this inflation target would require substantial balance sheet expansion by the BOJ.

As Chris Wood aptly puts it, the move by the BOJ is merely the latest evidence of the bull market in central bank balance sheet expansion and more importantly, relative central bank balance sheet. In a world where export driven growth is seen as everyone as the way out of debt purgatory you need expand and print more than your peers. On this, I also slightly disagree with Chris that Japan does not need a weaker JPY. My own analysis suggest that corporate margins in Japan are very sensitive to changes in the Yen. But that is a discussion for another time. For now, I will agree with Chris that we have seen the beginning of a sea change in Japan, but we need to see the BOJ backing up intentions.

Ultimately though, the most significant piece of news from Asia last week was the indication from both Japan and China that they would stand ready to offer their full support for the euro zone. The idea is simple; China and Japan would use the IMF as conduit to create the only real bazooka (apart from ECB monitisation).

Quote Bloomberg (my emphasis)

Japanese Finance Minister Jun Azumi said his nation and China will work together to help Europe solve its debt crisis through the International Monetary Fund.Europe needs a bigger so-called firewall of added funding to contain the crisis, even as Greece shows some improvement in solving its financial woes, Azumi told reporters in Beijing yesterday after meeting Chinese Vice Premier Wang Qishan. Azumi, who met Chinese Finance Minister Xiu Xuren during his visit, also said he asked China to make its currency more flexible.“We shared the view that Europe needs to make more efforts to create a bigger firewall,” Azumi said. “We also agreed to act together as the IMF will probably ask the U.S., Japan and China” to help boost its lending capacity.

This would indeed be global monetary relief from Asia.

CBO Nonsense

From the CBO Director’s blog:

Many factors are responsible for the rise in unemployment in general and in long-term unemployment:

-Weak demand for goods and services, as a result of the recession and its aftermath, which results in weak demand for workers;

The better question is: what is causing weak demand? Could it be that people are realizing that it’s fiscally unhealthy to spend lots of many that they don’t technically have? Could it be that the extend-and-pretend games of the last thirty years are starting to catch up to us? Could it be that, having pulled demand forward for so long, the future is now finally catching up to us?

-Mismatches between would-be employers’ needs and the skills or location of the unemployed;

This is actually a valid point, although it’s probably helpful to look at a couple of points that contribute to this situation. The declining value of an American education certainly contributes to mismatched needs and abilities. Interestingly, the sheer vapidity of modern American education is mostly due to Boomer tinkering. Also interesting is that Boomers are now in charge of major businesses, just in time to find out how terribly awry their experiments in education have gone. Furthermore, their arrogance and blind trust in their educational model prevented them from doing the one thing that would currently save their companies: hiring bright kids out of high school and training them on the job instead of waiting for them to get a college diploma. (Of course, it probably didn’t help that Boomers made employment testing illegal.)

Regarding location, I think there are three reasons people refuse to move for work. First, government benefits currently make staying in the same place to wait for a new job feasible. Second, I would theorize that most of the once-employed are intelligent to suspect that government benefits may not be around forever, and therefore it is best to stay where one is, since one will have more social capital at one’s current location than at a new location. Finally, the increasingly transient nature of jobs discourages employees from traveling, particularly in light of government benefits. Why endure moving a thousand miles away only to lose your job after a year? Especially when, after moving costs and loss of social capital are accounted for, you’re fiscally worse off than if you’d been on government benefits?

-Incentives for people to stay in the labor force and continue searching for work that result from extensions of unemployment insurance benefits; and

This is more of a technical point, as unemployment statistics are calculated by dividing the number of unemployed workers by the total labor force. The issue is defining the labor force (if memory serves me correctly, the government has six or seven definitions). Some metrics only consider adults that are currently looking for work as part of the labor force, and so the claim being made by the CBO is that rates are artificially (or, more accurately, tautologically) high because there are some who are looking for work instead of just giving up.

-The erosion of unemployed workers’ skills and the belief of some employers that people who have been unemployed for a long time would be low-quality workers (a phenomenon sometimes called stigma).

This is pretty much the same as above. As the social stigma that comes with long-term unemployment wears off, more of those workers who were at one time out of the labor force will come back into the labor force (by seeking jobs) and tautologically drive up the unemployment rate.

In all, the CBO is blaming increased unemployment rates on the fact that Americans are finally realizing that man cannot live by debt alone and on an increasing number of people who have the gall to seek employment again. In essence, the CBO would prefer that people continue to spend money they do not have and just go back to being lazy and unproductive. And that’s how the government plans on reducing unemployment.

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Paris Business District

Credits: Aéroports de Paris − LUIDER, Emile − LA COMPANY

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Economic Events on February 21, 2012

At 8:30 AM Eastern time, the Chicago Fed National Activity Index for January will be released, providing an update on economic activity and inflationary pressure in the United States.