japan's monetary alchemy may not yield gold

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    Japan's monetary alchemy may not yield gold
    By Richard Duncan
    Published: February 9 2004 20:43 | Last Updated: February 9 2004 20:43




    The most aggressive experiment in monetary policy ever conducted is now under way. Japan is printing yen in order to buy dollars in such extraordinary amounts that global interest rates are being held at much lower levels than would have prevailed otherwise. In essence, the Bank of Japan is carrying out the unorthodox monetary policy that the US Federal Reserve intimated it was considering in mid-2003. In other words, the BoJ is creating money and buying US Treasury bonds, which is helping to drive down US interest rates and underwrite US economic growth - and, by extension, global growth.





    It is inconceivable that economic policymakers in Tokyo and Washington do not understand the impact that this unprecedented act of money creation is having on global interest rates and economic output. The amounts involved are staggering. Since the beginning of 2003, monetary authorities in Japan have created Y27,000bn with which they have acquired approximately $250bn - that amount is equivalent to more than 4 per cent of Japan's gross domestic product. It also represents $2,000 for every person in Japan. In fact, it would amount to $40 per person if divided among the entire population of the world. Most importantly, it is also enough to finance almost half of America's $520bn budget deficit this year.

    The amount of new yen that Japan "printed" and converted into dollars during January 2004 alone was enough to finance 13 per cent of the US budget deficit. The investment of those dollars into dollar-denominated debt instruments clearly explains why the yield on the 10-year US Treasury bond fell last month in spite of the 10 per cent upward revision in the Bush administration's budget deficit projections.

    By accident or by design, Japan is carrying out the most audacious endeavour to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720. So far, the results have been impressive. Japan's monetary alchemy has been the most important factor in allowing the US government to finance a $700bn deterioration in its budget over the past three years without pushing up US interest rates to levels that would pop the wealth-creating property bubble there.

    US tax cuts have fuelled domestic consumption. In turn, growing US consumption has shifted Asia's export- oriented economies into overdrive. China has played an important part in this process. With a trade surplus vis-à-vis the US of $125bn, equivalent to 9 per cent of its 2003 GDP, China has become a regional economic growth engine in its own right. China has used its large trade surpluses with the US to pay for its trade deficits with most of its Asian neighbours, including Japan. This recycling of China's US dollar export earnings explains the incredibly rapid "reflation" now under way across Asia. Even Japan's moribund economy has begun to show signs of export-oriented growth.

    These developments highlight a fundamental question that has been debated over centuries: can governments create money and make the population richer without setting in motion a chain of events that ultimately ends in monetary chaos? We may be about to find out as Japan tests the hypothesis on an unprecedented and global scale. If this experiment in unorthodox monetary policy succeeds, then we have arrived at a new international monetary paradigm. Governments will have discovered how to finance limitless deficits through the creation of paper money, and we all can look forward to an age of great prosperity. If it fails - as have all past attempts to create wealth from thin air - then the world may not be able to avoid a severe and protracted economic slump as the extraordinary imbalances in the global economy (caused by the explosion of fiat money in recent years) begin to unwind.

    In mid-2003, economists at the US Federal Reserve published a paper explaining why the Fed was not "out of bullets" despite having cut short-term interest rates to 1 per cent. That paper stated that "the Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter," if necessary, to stimulate the economy.

    Today, that helicopter is in the air. But, strangely, it is not the Stars and Stripes that is painted on its side, but rather the Rising Sun. That much is clear. What still is not quite discernible, however, is who is actually in the pilot's seat

















 
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