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The Reason Why the Japanese Central Bank is Playing With Fire

At its most recent meeting, the board of the Bank of Japan has –unsurprisingly- reconfirmed its plan to print 80 trillion Yen per month to expand the country’s monetary base to give the economy more oxygen to grow. However, the outcome of the vote wasn’t unanimous as one brave director has stepped up the plate and proposed to reduce the printing rate.

Kiuchi has been voting against the monthly 80 trillion package for quite a while now as he feels that the negative effects of continuing to print money are outweighing the potential benefits from the huge asset purchase program. We at Sprout Money agree with his view as the next chart of the Nikkei clearly shows how inflated the Japanese stock market currently is, and the risk for a total collapse is increasing day by day.

However, our main fear would be that a sudden shock in the confidence in either the central bank or the Japanese government could have devastating effects. Keep in mind the Bank of Japan currently is the largest buyer of the Japanese government bonds and if a sudden economic shock would result in an increased selling pressure on the government bonds, the Bank of Japan might be surprised by a wave of government bonds that could send the interest rate higher and crush the country’s export position.

The argument could be made that the Bank of Japan is just blindly buying the bonds without any reservation as the purchase rate of 80 trillion yen per month was upheld even after the credit ratings were downgraded. Kiuchi suggests this could be seen as evidence of an impairment of the market functioning as the existence and position of the Central Bank on the bond market has become overwhelming.

The reason why the Japanese central bank is playing with fire is because the bank doesn’t just purchase bonds to increase the liquidity and reduce the interest rates, it’s also directly investing in Real Estate Investment Trusts. It’s practically unheard of that a central bank is directly investing in real estate and the total annual commitment of 90 billion yen per year. On top of that, an additional 3 trillion yen ($25B) will be invested in ‘normal’ ETF’s. This actually makes the Bank of Japan look desperate and overstepping its boundaries when it comes to market intervention. The Bank of Japan is the first one to fold under the pressure to do more than just buying bonds and it will be interesting to see who will cave next.

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