Printapalooza throughout the world continues, but the Bank of Japan is leading the world in money creation. Printing inflates asset prices while deflating labor costs, i.e. wages. In the first chart, note the trend of Japanese wages since the BoJ began printing over a decade ago. It is not surprising that the Japanese economy is weak, because consumers have been on a slow, inexorable wage reduction for almost 15 years. The current round has proven ineffective at raising GDP growth, as illustrated in our second chart. Indeed, Japan witnessed stronger growth in the aftermath of Lehman than it is under Abenomics, which is also the last time Japanese inflation exceeded 2%. If you examine the third chart, you can see what happened after the last three times the mainstream financial press called an end to Japanese deflation.
In the meantime, the export and stock market gains fueled by the weak yen have probably peaked. The USDJPY exchange rate is highly correlated to the ratio between BoJ and Fed assets. As our last chart details, the market has already priced in the more rapid expansion of the BoJ’s balance sheet. A reduction in Fed purchases, the dreaded taper, will allow the yen to depreciate further.
The economic data continues to tell a tale of stagnation. The MFP is breathlessly reporting that the services PMI beat the consensus forecast despite the “shutdown.” Numbers above 50 signal expansion, but a 55.4 is nothing to write home about. Expected GDP growth at this level is below 2%, which is far below the 3.5% growth required to stir the labor market.
Everyone is trying to predict what the ECB will do on Thursday: will it cut rates or not? Most commentators seem to believe that the ECB will cut its discount rate, because the EU just cut its Eurozone growth forecast for 2014 to 1.1%. The EU has been relentlessly cutting growth forecasts since 2010, so there is no crisis here. The only thing you need to know about how the ECB will conduct monetary policy is contained in the chart above.
As long as the euro remains weak enough to promote German exports, there will be no rate cut to lower the euro exchange rate. If the euro attains and maintains the low $1.40’s for a time, then there will be a rate cut. At the current rate of $1.35, Germany is benefiting from both low inflation and a weak currency.