Sunday, September 23, 2012

BOJ's money printing is offset by households' cash hoarding

The Bank of Japan has been battling deflationary pressures and strong currency for years. Since the beginning of 2007, the yen has strengthened some 34% against the dollar, making Japanese goods more expensive and choking off the export sector. At the same time the nation constantly battles deflationary pressures that hurt capital investments. So how is it that with all the monetary expansion, BOJ is unable to make headway on this front (see discussion)?

The latest flow of funds data from BOJ provides a clue. The chart below compares cash held by Japan's households (6 months moving average) with the monetary expansion by BOJ, as the central bank buys Japanese government securities (bills and bonds). It shows that money "printing" in Japan is more than offset by cash hoarding.

Source: BOJ

This is exactly why deflation so dangerous. Cash becomes the best investment as deflation makes it "worth more" over time. That encourages households to save rather than spend or invest. Weak demand from households (and poor demand from abroad, in part due to the strong yen) in turn creates further deflationary pressure - and so on.

In the long run this is dangerous because at some point the ageing households will need to start using their savings, which could cause prices and interest rates to spike suddenly (see discussion). For now however BOJ will need to continue its perpetual QE program just to keep up with all the cash hoarding by households.
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