I do not often discuss the same subject two days in a row and even more rarely three but the ever worsening situation in Japan is an extreme event. Or at least we hope it is an extreme event! Again my sympathies go to them in their time of need. As to what has happened there was an explosion at the number 2 reactor of the troubled Fukushima Daiichi site (the third such explosion at this installation) and in addition there now is a fire at the number 4 reactor. Just to add to the tale of woe the official Japanese news agency is reporting that one of the pressure vessels of the reactors on this site is damaged. Radiation levels are rising quickly at the site and there are now reports that radiation levels are twenty times higher than normal in Tokyo itself with the only good part of this news being that radiation levels in Tokyo are usually quite low due to the geology there.
The Official Response: The Bank of Japan
It was only on Monday that the Bank of Japan responded to the crisis by adding 15 trillion Yen ( US $183 billion) of liquidity to calm money markets and to try to make sure that cash would not run out in Japan with the priority being the troubled North-East of Japan. In addition it doubled the size of its asset purchase programme from 5 trillion Yen to ten trillion Yen or US $122 billion . Some news agencies are saying that the total is now 40 billion for asset purchases but this (incorrectly in my view) includes 30 trillion Yen of loans.
The Bank of Japan responded to the deepening of the crisis today by adding a further 8 billion Yen (US $98 billion) of liquidity to the system as it struggles to deal with the consequences of this natural disaster for Japan’s money supply and monetary system.
I see that the Bank of Japan is coming under criticism for not doing more than it already is. If we look at what it is doing this is one of the circumstances when the response of a central bank to a request for cash is simply “how much do you want?”. In previous articles I have discussed this in relation to banking crises and a natural disaster is the same. This is what the Bank of Japan is doing.
Furthermore this is also a situation where, in my opinion, exchange-rate intervention can be effective. This is because it would be responding to a (hopefully) relatively short-term movement in the currency. This is a proper use of foreign exchange reserves as it can be unwound relatively easily after the crisis has passed. This is quite different to standing in the way of a long-term foreign currency trend in the way that both the Bank of Japan and the Swiss National Bank did in 2010 which had little effect and only accumulated losses which were large in the case of the SNB. So the Bank of Japan should stand ready to intervene if necessary and as I often point out with Japan she is likely to be intervening against currency strength rather than weakness. I have my own thoughts as to what may happen to the Yen as a longer-term effect of this but for now the natural tendency for the Japanese to repatriate savings from abroad has seen the Yen strengthen during this crisis.
Quantitative Easing in Japan
Quite different in my view are the calls for both an acceleration of and an expansion in the level of asset purchases planned by the Bank of Japan which is also known as Quantitative Easing. These are by no means a fine-tuning operation and even supporters of such a policy are likely to feel that a period of thought and reflection is required before any such programme is started. If nothing else how can anybody be sure what would be the right amount at a time of such great uncertainty? We plainly do not know. Also Japan has tried QE several times during the economic problems she has faced since the Nikkei collapsed in 1990 and we must remember that in spite of such programmes the “lost decade” has extended for 20 years now.
I am afraid that some of the supporters of such a programme do themselves no credit at all because what they actually appear to be asking for is a version of what has variously been called the Greenspan put option or more latterly the Bernanke put option. This strategy is where equity investors believe that they will never have to take large losses because the relevant central bank will take measures to always bail them out. As an example of this I see that the Vampire Squid ( Goldman Sachs) has called for such action today and at the same time my memory points out that they recently went bullish on the Nikkei and gave recommendation to buy it at around the 10,500 level. In my view bailing out equity investors is not one of the roles of a central bank as at a time of crisis like this it has more important things to do.
The Market Response
I watched the opening of the Japanese equity market (midnight UK time) and both the Nikkei 225 and Topix equity index were quickly down by around 4%. This was significant as because of the way that prices and volumes are matched Japanese markets can react more slowly in the short-term than western ones. As the news from the stricken reactors deteriorated the Nikkei collapsed to 8228 at one point in what was a panicked and fevered atmosphere before recovering to close only (?) 1015 points lower at 8605.
I have seen many views advanced on what may happen to the Yen but if we look at its moves versus the US dollar we see a rally in it from around 83 pre-disaster to 81.4 now. Knowing the Japanese as I do they are likely to be repatriating funds to help with the crisis and this combined with some currency investors anticipating this seems ample explanation for the rise. Looking further forward once the repatriation of funds ends it is not impossible that we may have finally found an event which halts and maybe even reverses the rise in the Yen. As discussed in the comments section yesterday if nothing else Japan is likely to have to import even more fuel to replace the power that was provided by the stricken reactors. This will have to be paid for….
European equity markets are being hit hard this morning as the possible consequences of the radiation leaks are considered. The UK FTSE 100 is down nearly 3% as I type this and the German Dax index has fallen by over 300 points or nearly 5%. Should the situation remain the same in Japan then America’s equity markets are likely to be affected in a similar fashion.
Government Bond Markets rally
These tend to rally at times like this and accordingly we are seeing a reversal of the trend that has been in place for the last 6 months or so. World economic fundamentals get swamped by the crisis effects of a “flight to quality” or safety and the fact that world economic growth is now likely to be lower than previously thought. If we use the ten-year US Treasury Bond as a world benchmark we can see that yields which were testing the 3.6% level at the peak are now at 3.37% which means there will have been a decent rally in price terms.
In the UK our equivalent ten-year yield had gone above 3.8% but has now fallen to 3.63% as similar effects take place. Rather ironically it does provide a favourable backdrop to the Euro zone deal which was announced at the weekend! In a favourable accident of timing they have events in their favour for once so it may take slighty longer than normal for the flaws in their plan to be spotted.
I am reminded at a time like this of the power of nature and the relative weakness of man. If we put such thoughts into the economic sphere I would like to look at again the theme that I have developed which is of central banks interfering ever more in world affairs. Apart from the problems I have suggested with this philosophy before we have yet a new example of “the unexpected” damaging their plans. I hope that they will realise that it is their philosophy which is wrong rather than try to intervene even more.
Also I would like to thank everyone for the quality of their comments which is a strength of this blog. Also I do have updates ready on other issues such as the Euro zone plan but right now all eyes are on the most significant event which is/are the developments in Japan.
The news media has had various forecasts over the last 48 hours of the scale of the crisis and many of these also try to tell us the scale of this catastrophe and come with a promise of a recovery which is fast. I will leave you with one thought, exactly how do they know that?