The Yen Offers a Lesson in QE

 | Jun 04, 2013 | 5:00 PM EDT
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Back on May 20, I wrote a column discussing the yen and the likelihood that its six-month selloff may have ended. The dollar/yen was around 102 at the time. After falling to the 98 handle yesterday, it's just above 100 today. My recommendation on the CurrencyShares Japanese Yen Trust (FXY) has also done nicely: It's up about 3% in that time.

The rationale for being bullish on the yen (short USD/JPY) was that I just didn't see how all these claims of "yen printing" are justified. I gave the example of the "dollar printing" meme that has been so rampant. Despite five years of extraordinary monetary actions from the Federal Reserve and cries of dollar printing, the dollar, as measured by the Dollar Index (DXY) is up, not down.

Yes, I can understand that portfolio shifts can occur when large numbers of market participants misunderstand monetary operations, and yes, I can understand the media's incessant hammering of this completely wrong story. But quantitative easing and other central-bank measures to reduce rates do not equate to the creation of new dollars or yen or pounds or Swiss francs or anything else. All that happens is that the economy gets stripped of one asset and gets another one in its place. Nobody has any more money. In fact, as I have explained before, QE really acts like a tax, in that it removes income via that interest channel.

Granted, portfolio shifts can play out over a long period of time, and since we're potentially talking trillions, that can mean moves of very large magnitude. Case in point: the dollar was all over the place in the past five years, but it's higher now than in 2008.

The same pattern looks likely to play out for the yen. Sooner or later (and perhaps sooner), people are going to realize that without large, fiscal injections (real money printing), QE or other monetary operations by the Bank of Japan equate to nothing in terms of yen creation or generating inflation.

Honestly, I am baffled at how people don't seem to grasp this. The Bank of Japan has been conducting QE for the last 20 years, and it has not been able to create one iota of inflation. Indeed, it has thrown everything but the kitchen sink at the economy from a monetary perspective, causing yen reserves in the banking system to skyrocket, and there is still no inflation. You'd think people would start to question this outlook by now. But they're still somehow convinced that this time it will be different. Isn't that the definition of insanity?

One thing may give some solace to the yen bears: Japan's current account balance remains negative. This will likely weigh on the yen and mitigate any strong rally that would otherwise come as a result of the falsely understood monetary environment. As I wrote in my article last month, Japan's trade deficit has been due to the closing of the nation's nuclear reactors, which has caused the country to run up a huge tab for oil imports. That may soon be changing, however, as the Shinzo Abe administration is now pressing forward with plans to restart some of those nukes. Approval of this plan may come as early as June 14, and if the government gives the green light for a restart, that would light a fire under the yen.

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