Koo: Currency Markets Are Misinterpreting the Impact of QE

Timely commentary from Richard Koo of Nomura here who says that the currency markets are misunderstanding the impact of QE.   Given the BOJ’s open-ended commitment to QE that was just announced, it’s interesting to see how the markets are indeed responding to the big talk out of BOJ.  Whether they can deliver is a whole different matter.  Koo clearly thinks they can’t:

“I worry that recent moves in the forex market have been driven solely by announcements regarding quantitative easing and not by the relative changes in actual money supply.

This is an indication that many forex market participants remain unaware that the relationship between the money supply and the monetary base has since 2008 (and since 1990 in Japan) morphed into something very different to what the textbooks predict.

Prior to these bubbles, base money and the money supply tracked each other almost perfectly across the industrialized world. Knowing one of these variables, it was easy to assume what had happened to the other. Since the bubbles burst, however, this relationship—like the one between base money and inflation—has collapsed.

Behind the breakdown of both these linkages is the fact that the private sector, which is dealing with balance sheets impaired by the collapse of an asset bubble, has not only stopped borrowing but has also been paying down debt, prompting the money multiplier to turn negative at the margin at times.

That is why central bank monetary policy has lost so much of its potency in Japan and other developed economies in the postbubble era.”

As I’ve said before, this is one of the most interesting policy experiments currently occurring in the world.  If the BOJ succeeds here it could change the way the world approaches policy.  Indeed, the concepts of the “wealth effect” and talking up markets will become an even more pervasive and outright policy approach.

Source: Nomura

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:
TwitterLinkedIn

  • Alberto

    Ok, now suppose instead that this experiment by FED, BOJ, BCE… fails. What will happen next ?

  • Innocent_Bystander

    Gosh. Economic prosperity is so easy. We just need to put a number on the S&P and tell traders to bid it up to there. I’m sure this will end well.

  • mike

    FSM help us all…

  • Dave Holden

    Puzzled. Is this QE as we know it, swapping government debt for reserves? If so why would this effect stocks other than changing portfolio preference. #confused.

  • INDIGNADO

    Cullen, you seem pretty confident that this BOJ experiment will work. I have the same concerns as Albert. And if it doesn´t? How could this play out.

  • MacroTrader

    Poorly…

  • Cowpoke

    Does this mean that Peter is in uncharted teratory with all his new found T-Bonds?

    “Prior to these bubbles, base money and the money supply tracked each other almost perfectly across the industrialized world. Knowing one of these variables, it was easy to assume what had happened to the other. Since the bubbles burst, however, this relationship—like the one between base money and inflation—has collapsed.”

  • LRM

    I thought it was the view of MR that such wealth effects were small and that the effects would be short duration.

  • Alberto

    This is the end my friends… the only end

    … Columbia Professor Michael Woodford, the world’s most closely followed monetary theorist, says it is time to come clean and state openly that bond purchases are forever, and the sooner people understand this the better.

    “All this talk of exit strategies is deeply negative,” he told a London Business School seminar on the merits of Helicopter money, or “overt monetary financing”…

    … Let’s go further and eliminate government debt on the bloated balance sheet of central banks,” he said. This could done with a flick of the fingers. The debt would vanish…

    … Lord Turner, head of the now defunct Financial Services Authority (UK), made the point more delicately. “We must tell people that if necessary, QE will turn out to be permanent.”…

    http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9970294/Helicopter-QE-will-never-be-reversed.html

  • John Wilkins

    I have the same question as Dave Holden. The Fed’s asset purchases are adding to reserves which is a giant spread sheet with electronically produced numbers. Their purchases have not been adding to the money supply that buys things, thus it is not inflationary. So why would the BOJ QE be any different? What could this BOJ QE do when Japan already has near zero rates. Is it only a psychological impact where people believe it will be inflationary and thus act today versus next year (e.g. buy stocks)?

  • jt26

    Does anyone really know how the BoJ works? I’ve looked on/off over the last few years and haven’t been able to find the details.

    On another note, one thing that Japan does have (vs. the US) is close coordination of corporations and the government … it has been a big question whether the corporates have been positioned correctly to be short the Yen and how to take advantage of it. Also, I think most people misunderstand Japan. Japan could care less about the average Japanese citizen; the government exists for the corporations, and the effectiveness or not of government policy should be seen in this light.

  • Alberto

    “the (japanese) government exists for the corporations, and the effectiveness or not of government policy should be seen in this light”

    like all the other govs man !

  • Cowpoke

    As the central bank of Japan, the Bank of Japan issues banknotes (Bank
    of Japan notes). The Bank works to maintain the stability of prices and the
    financial system to ensure the trustworthiness of money as a means to settle
    economic transactions. The Bank conducts various business operations,
    including conducting monetary policy and fulfilling the function of being the
    lender of last resort, in order to contribute to the steady development of the
    Japanese economy. This chapter gives an overview of the functions and operations
    of the Bank.
    http://www.boj.or.jp/en/about/outline/data/foboj03.pdf

  • jt26

    True. True. True. ;-}

    But, in the same way early Fed policy in 2009 was to save and recap the banks, I think the BoJ is hoping that the injection of yen into the banking sector will
    embolden the banks to expand their balance sheets with more USD assets gained from selling Yen, which will not only increase their net worth, but increase the local yen loan book as exporters rev up. The BoJ has aready stated they will not expand their MB via foreign bond purchases.

  • http://www.nowandfutures.com bart

    “Since the bubbles burst, however, this relationship—like the one between base money and inflation—has collapsed.”

    If one subtracts the huge amount of excess reserves from base, the relationship between it and CPI-U based inflation is much much closer. It’s not broken as Koo incorrectly asserts.

    http://www.nowandfutures.com/images/base_less_excess_reserves.png

  • jt26

    Thanks Cowpoke. I was more specifically interested in whether the Japanese system is like the US described by Cullen, i.e. QE bonds are swapped for reserves and remained trapped in the banking system. (Although, I don’t think this is a problem for Japan since they’re hoping the turn around will be initiated by the banking system (see my comment below)).

  • Kristian Blom

    The Japanese experiment will not “work”. There will be no sustainable end to disinflation and periodic deflation as a result of monetary policy. As this morning shows the adjustment is a simple case of social engineering; shifting wealth from one asset (asset holder) to another.

    In aggregate no value has been added. Capitalism needs to be allowed to work without the intervention of well intentioned central planning based on ivory tower theories of how things “should” work.

    Kristian

  • Cowpoke

    Answering concerns that the stimulus programme would further raise Japan’s public debt, the statement said that the government bond purchases would be “executed for the purpose of conducting monetary policy and not for the purpose of financing fiscal deficits”.

    http://www.guardian.co.uk/business/2013/apr/04/japan-bank-money-supply-inflation-deflation

  • http://www.capitaloneforex.com/ forextrading

    Capital One Forex offers easy and secure facilities to perform online deposits. Our trading environment supports multiple currencies and a wide range of payment methods such as MoneyBookers WebMoney, credit and debit cards and Bank Wire transfers.