Podcast

Japan YCC fails, Bullwhips, and Fragmentation - FED100

This post is to provide the associated images and commentary for the audio podcast.

Fed Watch is the macro podcast for bitcoiners. Each episode we discuss current events in macro from across the globe, with an emphasis on central banks and currencies.

In this episode, CK and I cover developments in Japan in regards to Yield Curve Control, in the US in regards to growth and inflation forecasts, and in Europe in regards to the concern about fragmentation. At the end of the episode, we celebrate the 100th episode of Fed Watch by reviewing some of the guests and calls we have made throughout the show's history.

Big Trouble in Japan

The economic troubles in Japan are legendary at this point. They have suffered through several lost decades of low growth and low inflation, addressed by the best monetary policy tools of the day, by some of the best experts in economics (maybe that was the mistake). None of it has worked, but let's take a minute to review how we got here.

Japan entered their recession/depression back in 1991 after their giant asset bubble burst. Since that time, their growth has been averaging roughly 1% a year, with low unemployment, and very low dynamism. It's not negative GDP growth, but it's the bare minimum to have an economic pulse.

To address these issues, Japan become the first major central bank to launch into Quantitative Easing (QE) in 2001. This is where the central bank, Bank of Japan (BOJ) would buy government securities from the banks in an attempt to correct any balance sheet problems, clearing the way for those banks to lend (aka print money).

That first attempt at QE failed miserably, and in fact, caused growth to fall from 1.1% down to 1%. The Japanese were convinced by Western academic economists, like Paul Krugman, who claimed the BOJ failed because they had not "credibly promised to be irresponsible". They must change the inflation/growth expectations of the people by shocking them into inflationary worry.

Round two of monetary policy in 2013 was dubbed QQE (Quantitative and Qualitative Easing). In this strategy, the BOJ would cause "shock and awe" at their profligacy, buying not only government securities but other assets like ETFs on the Tokyo stock market. Of course, this failed, too.

Round three was the addition of Yield Curve Control (YCC) in 2016, where the BOJ would peg the yield on the 10-year Japanese Government Bond (JGB) to a range of ±10 bps. In 2018, that range was expanded to ±20 bps, and in 2021 to ±25 bps, where we are today.

The YCC Fight

Source: Fisher Investments

As the world is now dealing with massive price rises due to the economic hurricane, the government bond yield curve in Japan is pressing upward, testing the BOJ's resolve. As of now, the ceiling has been breached several times, but it hasn't complete burst through.

Source: bitcoinandmarkets.com

Source: bitcoinandmarkets.com

The BOJ now owns more than 50% of all government bonds, on top of their huge share of ETFs on their stock exchange. At this rate, the entire Japanese economy is going to be owned by the BOJ soon.

Source: Twitter

The Yen is also crashing against the dollar. Below is the exchange rate, how many yen to a US dollar.

Source: bitcoinandmarkets.com

Federal Reserve DSGE Forecasts

Federal Reserve Chairman, Jerome Powell, went in front of Congress this week and said that a US recession was not his "base case", despite nearly all economic indicators crashing in the last month.

Here we take a look at the Fed's own DSGE model.

The New York Fed DSGE (dynamic stochastic general equilibrium) model has been used to forecast the economy since 2011, and its forecasts have been made public continuously since 2014.

The current version of the New York Fed DSGE model is a closed economy, representative agent, rational expectations model (although we deviate from rational expectations in modeling the impact of recent policy changes, such as average inflation targeting, on the economy). The model is medium scale, in that it involves several aggregate variables such as consumption and investment, but is not as detailed as other, larger, models.

As you can see below, the model is predicting this year's Q4 to Q4 GDP to be negative, as well as the 2023 GDP. That checks with my own estimation and expectation that the US will experience a prolonged but slight recession, while the rest of the world experiences a deeper recession.

In the below chart, I point out the return to the post Great Financial Crisis (GFC) norm of low growth and low inflation, a norm shared by Japan by the way.

Source: NY Fed DSGE Model

European Anti-fragmentation Cracks

Only a week after we showed watchers and listeners of Fed Watch ECB President Christine Lagarde's frustration at the repeated anti-fragmentation questions, EU heavyweight, Dutch Prime Minister Mark Rutte, comes through like a bull in a china shop.

I read parts of an article from Bloomberg, where Rutte claims it's up to Italy, not the ECB, to contain credit spreads.

What's the big worry about fragmentation anyway? The European Monetary Union (EMU, aka Eurozone), is a monetary union without a fiscal union. The ECB policy must serve different countries with different indebtedness. This means that ECB policy on interest rates will affect each country within the union differently, and more indebted countries like Italy, Greece and Spain will suffer a greater burden of rising rates.

The worry is that these credit spreads will lead to another European Debt Crisis 2.0, and perhaps even political fractures as well. Countries could be forced to leave the Eurozone and/or the European Union itself over this issue.

Lookback on 100 Episodes

The last part of this episode is spent looking back at some of the predictions and great calls we've made. It didn't go according to my plan, however, and we got lost in some weeds. But overall, we were able to highlight the success of our unique theories put forward by this show in the bitcoin space.

1) Strong dollar
2) Bitcoin and USD stablecoin dominance
3) US's relative decentralization makes it a better fit for bitcoin
4) Bearish on China and Europe

We also highlight some specific calls that have been spot on, which you'll have to watch the episode to hear.

I wanted to highlight these things to show the success of our contrarian views, despite being unpopular amongst bitcoiners. This show is an important voice in the bitcoin scene because we are prodding and poking the narratives to find the truth of the global monetary system.