Bank of Japan: Feeling the Squeeze of Quantitative Easing
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Bank of Japan: Feeling the Squeeze of Quantitative Easing

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Since the 2008 financial crisis, the term “quantitative easing” (QE) has become ubiquitous in financial circles and well known even amongst the general public. When conventional monetary policy — the manipulation of short-term interest rates — failed to stimulate lending and growth, the world’s central banks turned to QE in an attempt to lower longer-term rates. QE became the solution of choice for the U.S. Federal Reserve, the European Central Bank (ECB), the Bank of Japan and the Bank of England. There is still some debate about the effectiveness and efficiency of QE as an economic stimulant; indeed, its side effects may be as important as significant as its intended consequences.

Strictly speaking, QE does not involve “printing money”, although its impacts can be similar. QE is officially meant to lower interest rates in the longer-term debt markets, to encourage lending and borrowing activity, and to increase the money supply. This tends to cause price increases in asset markets and to fuel consumption, but also (more troublingly) general inflation. QE also tends to weaken the local currency, a boon to exporters but a drain on domestic demand for foreign goods. And as with any inflation, the value of debt and interest payments erodes, benefiting borrowers at the expense of lenders. Complicating matters further, domestic inflation can actually raise the real exchange rate, and liquidity released by QE can flow into global commodity markets, transmitting inflation around the world. 

Critics of the Bank of Japan first coined the term “quantitative easing” more than 10 years ago . More recently, it surprised many observers by announcing another round of easing earlier than expected on Wednesday September 19th, to the value of 10 trillion yen. At first glance, it would seem that this latest move by Japan’s central bank was a complement to the similar measures taken by the Fed (“QE3”), the ECB and the Bank of England, in an effort to give the global economy a much-needed pick-me-up.  However, the fine print of Japan’s plan suggests that, this time, the main target was the yen. In other words, it appears to be a quiet salvo in an ongoing “currency war” in which a number of countries are trying to quietly devalue their currency in order to help exporters, a “beggar-thy-neighbour” policy that seeks to gain a larger slice of the global demand pie. The ongoing U.S. – China stoush over Beiijing’s alleged attempts to depress the yuan is only the most visible front in the conflict. The euro, the British pound, the U.S. dollar, the Brazilian real and the Swiss franc are also implicated – as is the Japanese yen.

On a recent trip to Osaka, Masaaki Shirakawa (the Bank of Japan’s Governor) was put under pressure  by a number of large Japanese electronics firms, who warned that the strong yen was doing major damage to their business. Japanese growth has remained anaemic in recent years; the currency-depreciating side effects of further QE were probably a strong factor in deciding to announce additional easing at the earlier date.  

For Japan the situation is especially complicated.  Post-Fukushima, the country’s renewed reliance on imported fossil fuels means that a weaker yen will harm energy consumers even as it benefits exporters.

For the eurozone, currency value is a sensitive topic. Recent developments have helped market confidence: the ECB announced on September 6 that it would commit to unlimited bond purchases for floundering European governments, and the following week the German constitutional court approved the establishment of the eurozone’s new rescue fund, the European Stability Mechanism. But upbeat investors have produced the unwanted side effect of pushing up the euro against the dollar. The struggling periphery nations need a much weaker currency to improve their international competitiveness, whilst the core countries will suffer if the euro climbs much higher – especially given the weaker U.S. dollar and the downward pressure on the British pound, Japanese yen and Chinese yuan.

The inflationary effects of QE were also probably on the minds of the four central banks whose countries are all struggling, in one form or the other, with high levels of debt (especially government debt.)  Inflating away debt (“monetizing” debt) has been an accusation levelled at both Japan and the U.S. in recent years, and especially angers foreign speculators who see value eroded in nominal terms (through currency depreciation) and in real terms (through inflation). This is especially significant for China, with its large holdings of U.S. dollars. China has the world’s biggest foreign exchange reserve, to the tune of around $3.2 trillion.

In this latest move, other countries’ aggressive tactics have forced the Bank of Japan’s hand.  As the QE debate rages, everyone from gold investors to central bankers to opposition parties is weighing in. QE is a complicated issue, and we probably won’t be able to judge its final effectiveness until much further down the track.

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