Hi, thanks for this interesting post. I always make time to read your articles.
If that’s OK, I’d just like to point out a couple of things. In the first chart, if the RHS axis is for the nominal yen (the yen per dollar rate) then it should be reversed (the axis, not the line). The all time high of the nominal yen (max yen strength, i.e. min yen per dollar) was in early 2012 at about 76. You can also see that your latest (2024?) observation is at around 100, while in actual fact it’s around 140.
It may also be worth checking the definition of your real exchange rate index (is up a stronger or a weaker RER?). The yen RER these days is at a point of multi-decade weakness, which makes Japan Inc. very (price) competitive as anyone who has travelled to Japan recently can attest to: Japan is cheap, i.e. the purchasing power of the yen is low/of foreign currencies high. That is a combination of both a weak nominal yen and of a low Japan price level relative to other countries (or chronically lower Japanese inflation).
Lastly, the contributor above is right to point out that banks create loans, and hence deposits (= money) out of thin air. This also means that the money multiplier (M/monetary base) is a meaningless quantity (the base is mostly central bank reserves, which must be held by commercial banks), banks “do not lend out” base money, they can just create deposits at will by deciding to lend. Borio and Disyatat of the BIS have some useful papers on this (around 2010-12), also see a nice Bank of England article called something like “Money creation in the modern economy”.
Your point about changes in the overnight rate differential not translating into an identical change in the 10y differential is a good one, with one caveat, however. During YCC, the (real) 10y JGB rate became the policy target of the BoJ, hence it correlated more closely with USDJPY than a short rate differential. They are now transitioning away from YCC (slowly), so the exchange rate may over time become more responsive again to the short rate differential.
In the first chart, if the RHS axis is for the nominal yen (the yen per dollar rate) then it should be reversed (the axis, not the line).
THIS IS NOT A MEASURE OF THE YEN/$ BUT, AS STATED IN THE POST, AN INDEX OF THE NOMINAL VALUE VISAVIS ALL OF JAPAN'S TRADING PARTNERS. iN THE NOMINAL AND REAL, A HIGHER NUMBER INDICATES A STRONGER YEN, I.E. A YEN WITH GREATER PURCHASING POWER.. IF SOMEONE LIKE YOU DIDN'T GET THIS, THEN I NEED TO EXPLAIN IT MORE.
BEING PRICE COMPETITIVE VIA FIRESALE PRICES IS NOT THE SAME AS BEING GENUINELY COMPETITIVE VIA PRODUCTIVITY AND INNOVATION THAT ALLOWS PREMIUM PRICES. THE ULTIMATE MEASURE IS BEING ABLE TO COMPETE IN WORLD MARKETS WHILE STILL RAISING WAGES AND LIVING STANDARDS.
Lastly, the contributor above is right to point out that banks create loans, and hence deposits (= money) out of thin air.
NOT SO. DEPOSITS COME IN, OUT OF WHICH THEY LEND, SAY, 90%, AND THEN A BUSINESS WHICH BORROWED THE MONEY DEPOSITS ITS REVENUE AND THAT ALLOWS THE BANKS TO LEND STILL MORE. IF COMPANIES AND CONSUMERS DON'T WANT TO BORROW AND SPEND, EVEN AT ZERO INTEREST RATES, THEY CANNOT LEND "OUT OF THIN AIR."
Your point about changes in the overnight rate differential not translating into an identical change in the 10y differential is a good one, with one caveat, however. During YCC, the (real) 10y JGB rate became the policy target of the BoJ, hence it correlated more closely with USDJPY than a short rate differential. They are now transitioning away from YCC (slowly), so the exchange rate may over time become more responsive again to the short rate differential.
I DON'T BUY YOUR LOGIC BECAUSE FED RATES CHANGED, BUT I'LL TAKE A GANDER WHETHER 2-YR RATE DIFFERENTIALS HAVE A HIGHER CORRELATION.
NOT SO. DEPOSITS COME IN, WHICH THEY USED TO LEND TO COMAPANIES AND HOUSEHOLDS TO BIY SOMETHING. THEN THE BUSINESS THAT SOLD THEM THE STUFF MONEY DEPOSITS ITS REVENUE AND THAT ALLOWS THE BANKS TO LEND STILL MORE. AND THE PROCESS MULTIPLIES FAR BEYOND THE ORGINAL DEPOSIT. IF COMPANIES AND CONSUMERS DON'T WANT TO BORROW AND SPEND, EVEN AT ZERO INTEREST RATES, THEY CANNOT LEND "OUT OF THIN AIR."
"Japan’s banks can no longer lend enough to use all the deposits that they take in"
Richard - sorry to be anal, but as Professor Werner has shown empirically, banks do not lend out deposits, they create new deposits from nothing when extending loans. Instead, deposits are invested in securities to generate a return. So unless I am missing something, there is no such issue of banks not being able to "use up" excess deposits.
Presumably instead the huge amount of corporate cash hoarding is actually providing banks with a safer and more liquid return than they would get on lending to corporates?
There is a general process in the money supply in which deposits and and loans help each expand through what it called the money multiplier. That has nothing to do with the issue I raised. I cannot speak for other countries, but in Japan, the banks are not investing in securities like low-yielding JGBs because they prefer that, but because borrowing levels by companies and consumers are so low.
Hi, thanks for this interesting post. I always make time to read your articles.
If that’s OK, I’d just like to point out a couple of things. In the first chart, if the RHS axis is for the nominal yen (the yen per dollar rate) then it should be reversed (the axis, not the line). The all time high of the nominal yen (max yen strength, i.e. min yen per dollar) was in early 2012 at about 76. You can also see that your latest (2024?) observation is at around 100, while in actual fact it’s around 140.
It may also be worth checking the definition of your real exchange rate index (is up a stronger or a weaker RER?). The yen RER these days is at a point of multi-decade weakness, which makes Japan Inc. very (price) competitive as anyone who has travelled to Japan recently can attest to: Japan is cheap, i.e. the purchasing power of the yen is low/of foreign currencies high. That is a combination of both a weak nominal yen and of a low Japan price level relative to other countries (or chronically lower Japanese inflation).
Lastly, the contributor above is right to point out that banks create loans, and hence deposits (= money) out of thin air. This also means that the money multiplier (M/monetary base) is a meaningless quantity (the base is mostly central bank reserves, which must be held by commercial banks), banks “do not lend out” base money, they can just create deposits at will by deciding to lend. Borio and Disyatat of the BIS have some useful papers on this (around 2010-12), also see a nice Bank of England article called something like “Money creation in the modern economy”.
Your point about changes in the overnight rate differential not translating into an identical change in the 10y differential is a good one, with one caveat, however. During YCC, the (real) 10y JGB rate became the policy target of the BoJ, hence it correlated more closely with USDJPY than a short rate differential. They are now transitioning away from YCC (slowly), so the exchange rate may over time become more responsive again to the short rate differential.
Thanks again for a very useful post.
Regards, Spyros
See below
In the first chart, if the RHS axis is for the nominal yen (the yen per dollar rate) then it should be reversed (the axis, not the line).
THIS IS NOT A MEASURE OF THE YEN/$ BUT, AS STATED IN THE POST, AN INDEX OF THE NOMINAL VALUE VISAVIS ALL OF JAPAN'S TRADING PARTNERS. iN THE NOMINAL AND REAL, A HIGHER NUMBER INDICATES A STRONGER YEN, I.E. A YEN WITH GREATER PURCHASING POWER.. IF SOMEONE LIKE YOU DIDN'T GET THIS, THEN I NEED TO EXPLAIN IT MORE.
BEING PRICE COMPETITIVE VIA FIRESALE PRICES IS NOT THE SAME AS BEING GENUINELY COMPETITIVE VIA PRODUCTIVITY AND INNOVATION THAT ALLOWS PREMIUM PRICES. THE ULTIMATE MEASURE IS BEING ABLE TO COMPETE IN WORLD MARKETS WHILE STILL RAISING WAGES AND LIVING STANDARDS.
Lastly, the contributor above is right to point out that banks create loans, and hence deposits (= money) out of thin air.
NOT SO. DEPOSITS COME IN, OUT OF WHICH THEY LEND, SAY, 90%, AND THEN A BUSINESS WHICH BORROWED THE MONEY DEPOSITS ITS REVENUE AND THAT ALLOWS THE BANKS TO LEND STILL MORE. IF COMPANIES AND CONSUMERS DON'T WANT TO BORROW AND SPEND, EVEN AT ZERO INTEREST RATES, THEY CANNOT LEND "OUT OF THIN AIR."
Your point about changes in the overnight rate differential not translating into an identical change in the 10y differential is a good one, with one caveat, however. During YCC, the (real) 10y JGB rate became the policy target of the BoJ, hence it correlated more closely with USDJPY than a short rate differential. They are now transitioning away from YCC (slowly), so the exchange rate may over time become more responsive again to the short rate differential.
I DON'T BUY YOUR LOGIC BECAUSE FED RATES CHANGED, BUT I'LL TAKE A GANDER WHETHER 2-YR RATE DIFFERENTIALS HAVE A HIGHER CORRELATION.
Regards, Spyros
CORRECTION ON ANSWER TO BANKS:
NOT SO. DEPOSITS COME IN, WHICH THEY USED TO LEND TO COMAPANIES AND HOUSEHOLDS TO BIY SOMETHING. THEN THE BUSINESS THAT SOLD THEM THE STUFF MONEY DEPOSITS ITS REVENUE AND THAT ALLOWS THE BANKS TO LEND STILL MORE. AND THE PROCESS MULTIPLIES FAR BEYOND THE ORGINAL DEPOSIT. IF COMPANIES AND CONSUMERS DON'T WANT TO BORROW AND SPEND, EVEN AT ZERO INTEREST RATES, THEY CANNOT LEND "OUT OF THIN AIR."
"Japan’s banks can no longer lend enough to use all the deposits that they take in"
Richard - sorry to be anal, but as Professor Werner has shown empirically, banks do not lend out deposits, they create new deposits from nothing when extending loans. Instead, deposits are invested in securities to generate a return. So unless I am missing something, there is no such issue of banks not being able to "use up" excess deposits.
Presumably instead the huge amount of corporate cash hoarding is actually providing banks with a safer and more liquid return than they would get on lending to corporates?
There is a general process in the money supply in which deposits and and loans help each expand through what it called the money multiplier. That has nothing to do with the issue I raised. I cannot speak for other countries, but in Japan, the banks are not investing in securities like low-yielding JGBs because they prefer that, but because borrowing levels by companies and consumers are so low.