Notes From Underground

On Thursday Rick Santelli pushed and prodded and as a result, we were able to travel from Japan to Europe in an effort to discuss some of the more pressing issues confronting the global macro world. First, we stopped in Japan to discuss how the BOJ and Governor Kuroda will be able to extricate itself from five years of QQE which has seen the BOJ accumulate Japanese debt and equities. Of course the end game is to reach the self-imposed inflation level of 2 percent that has proved to be an agonizing level to achieve. As a reminder, when a nation is saddled with huge debts the best relief is to be found in inflation, which results in an ultimate money illusion as debts are paid back with an ever-depreciated currency.

Click on the image to watch me and Rick discuss global policy.

The Japanese have failed at achieving an “acceptable” measure of inflation for many reasons. Japan was in an outright deflationary for a decade as prices fell on an annual basis. This was a politically positive outcome because 97 percent of Japanese debt was owned by Japanese savers. Foreigners own a great deal of U.S. sovereign and corporate debt, who are not domestic voters.

The BOJ‘s QQE program has been under-purchasing assets because of the lack of Japanese bonds available in the market. The answer to the BOJ‘s problem may be the purchasing of foreign bonds by the central bank. However, that would not be acceptable to the Trump administration for it would result in a weakened. There are already rumors that Trump is complaining about the Japanese trade surplus with the U.S. due to the weak YEN. Prime Minister Abe will not wish to risk the ire of the Trump White House by invoking policies certain to weaken the YEN. There was a Reuters article today suggesting that Prime Minister Abe was “distancing himself from the BOJ inflation target.” If that’s true, the YEN OUGHT to have staged a strong rally but the YEN was the weakest currency on Thursday, weaker than the DOLLAR. So the Reuters headline lacked substance.

Interesting, the CHF/YEN and EUR/YEN both closed above the 200-WEEK moving averages, which points to further YEN weakness on a relative basis (further confirmation is needed). The Europeans will not be happy if the Japanese continue to pursue QQE as the ECB ends its asset purchase program.

Along with Japan, Rick and I discussed a common theme developed in NOTES FROM UNDERGROUND over the last several years. Mario Draghi’s QE program has put the ECB in a very tenuous position. At the ECB press conference last week, President Draghi stressed that while QE will stop purchasing new assets at the end of December the ECB will not begin shrinking its balance sheet but will merely purchase new assets when the current bonds are redeemed. Mario Draghi stressed the central bank will adhere to the sacrosanct CAPITAL KEY. Currently, that requires that German assets equal 18% of the total balance sheet, France at 14% and Italy at 12%.

The problem for the ECB is that German sovereign debt is diminishing as the German government  continues to run budget surpluses, shrinking the amount of available debt. The French and Italian governments continue to issue as much paper as possible–free money for some. Meanwhile, the demand for German debt high because they are high quality liquid assets desired in the post-crisis regulatory regime.

If my line of thinking is correct, the German /French spread OUGHT to widen once ECB asset purchases decline to 15 billion euros a month beginning October 1. This is a spread to watch for any cracks in the European financial edifice. THE GREATEST THREAT TO THIS CONCEPT WOULD BE THE INITIATION OF A EURO BOND and/or an announcement of French President Macron’s beloved unified financial insurance plan. If there is a solid plan then I will be WRONG. But does German Chancellor Merkel have the political strength to have Germany openly guarantee the entire European project?

This is the major issue looming on the European political horizon. If there is an  announcement of Bundesbank Bank President Weidmann becoming the head of the ECB then we shall be on the alert for some type of financial deal involving Italy and others. This is a critical issue as we head into the last quarter of the year.

Tags: Angela Merkel, BOJ, capital key, ECB, Euro, Europe, France, Germany, Japan, Kuroda, Mario Draghi, QQE, Yen

This entry was posted on September 20, 2018 at 7:59 pm and is filed under BoJ, Currency, ECB, France, Germany. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.