A Global Dearth Of Liquidity

The BoJ could not fail to notice that its QQE program had a number of drawbacks – one of them was that the Japanese government bond market essentially became paralyzed. It eventually decided to switch from buying a fixed amount of 80 trillion yen in JGBs every month to a policy of “controlling the yield curve”, or keeping the 10-year JGB yield between 0 and 0.1%.

As numerous articles at Bloomberg have reminded us in recent months, this has led to a kind of “stealth tapering”, as the BoJ’s JGB purchases have steadily decreased since then. Here is a recent chart illustrating the situation:

Actual JGB purchases by the BoJ (blue line) vs. purchases originally planned under QQE (orange line).

Once again the relationship between central bank activity and money supply growth was quite direct (i.e., there was very little time lag), something we have observed in all currency areas in which QE policies were enacted. Funny enough, Japanese banks are not really all that reluctant to lend – they are just not lending much in Japan (with the exception of real estate-related lending, which has grown quite a bit). Instead they have become even greater funding sources for the rest of the world than they already were previously.

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A number of remarkable data: recently the BoJ’s balance sheet has eclipsed the country’s GDP; real estate lending in Japan has grown rapidly; and so has lending to overseas clients, with both large international and regional banks in Japan amassing US dollar-denominated assets in size.

Readers may recall that the BoJ ended a previous QE program rather abruptly in 2006, shrinking its monetary base by almost 25% practically overnight. At the time we were surprised how little attention was paid to this maneuver. Later on we began to suspect that it was probably no coincidence that home prices in the US peaked right around the same time.

Clearly the yen carry trade was impaired by this sudden withdrawal of QE, which was inter alia reflected by a rapid decline in money supply growth. Of course, at present the BoJ is far from cutting back on anything – so far it has merely slowed the pace of its JGB purchases somewhat. But the pile of USD-denominated assets held by Japanese banks has become so large that it hangs over the markets like the sword of Damocles. It may not take much for it to fall.

King Dionysius shows the courtier Damocles his sword levitation trick, to demonstrate to him that one is constantly in peril as a king. According to Wikipedia, today the anecdote is “used to denote the sense of foreboding engendered by a precarious situation, especially one in which the onset of tragedy is restrained only by a delicate trigger or chance”.

China – Downtrend in Money Supply Growth Continues

We recently discussed the situation in China in some detail (see “Eastern Monetary Drought”, which includes additional charts and background information), so we will only show an update of the y/y growth rates of M1 and M2 here. Since our last missive, y/y growth in M2 has essentially remained stuck near a 20-year low of ~8.72%, while y/y growth in M1 has dipped below 4% for the first time since 2015.

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