Japan's Problems Will Not Be Solved By More QE, RBS Warns

One thing that became abundantly clear about QE long ago even if it hasn’t yet dawned on Mario Draghi or Haruhiko Kuroda, is that the practice of monetizing anything and everything that isn’t tied down (or that you can’t pry from the cold dead hand of an institutional investor), is subject to the law of diminishing returns. 

Put simply: eventually it just stops working in terms of stimulating aggregate demand and/or boosting growth and inflation expectations.

Unfortunately, the deleterious effects of QE are not subject to the same dynamic. 

That is, when you print another say, €750 million to monetize everything from periphery EGBs to SSAs to munis, you invariably impair market liquidity on the way to creating the conditions for dangerous bouts of volatility (see the great bund VaR shock for instance). 

Of course when you go full-Kuroda and simply corner the market for ETFs by stepping in to provide plunge protection at the first sign of Nikkei weakness, there’s no telling what kind of chaos you’ve set everyone up for once you step out of the market. Meanwhile, the mad dash to inflate the value of stocks and bonds has served to create enormous bubbles not only in those assets, but also in the things people who hold those assets are likely to buy when they get bored - like real estate and high end art. 

In short, the drug addiction analogy (as cliche as it now is) still holds up remarkably well. For a drug addict, the benefits (i.e. the high) diminishes the more the addiction grows, but the harmful effects on the body do not. It’s the same thing with QE. The initial “high” wears off, but the asset bubbles only grow. 

Nowhere is this more apparent than in Japan where just last night, we witnessed the unprecedented "quintuple recession": 

As if that wasn't bad enough, Japanese business spending dropped 1.3% QoQ - its worst drop since Q2 2014.

Of course the Nikkei is doing just fine, surging right alongside the BoJ's balance sheet.

In honor of Kuroda and his special brand of Peter Pan-inspired, neo-Keynesian madness, we present a bit of color from RBS' Alberto Gallo on Japan and QQE.:

Ok, so in other words: Kuroda isn't going to be able cure the country's structural problems which include the well worn issue of Japanese demographics as well the much maligned "deflationary mindset" which seems largely immune to the hum of the BoJ's prinitng press. Nevertheless, Japan is all-in and is apparently prepared to keep the pedal to the floor until 2018 when, as we've documented extensively, the game will officially be up (see here for instance).

In the meantime, as Gallo rightly points out, you can expect an impaired secondary market for JGBs, asset bubbles, and rising inequality (all outcomes we've discussed at great length) as Kuroda triples, quadruples, and quintuples down on policies that now seem to be producing around one recession per QE iteration. 

Summed up...