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Stagnation or recession: What threatens the banking system of Germany and the eurozone in 2020

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“One of Germany’s most acclaimed experts” in economic risk analysis, Marcus Krall, “predicts the collapse of the German banking system and the eurozone by the end of 2020.” Krall describes the euro as an “erroneous structure,” whose existence is maintained for political reasons. According to Krall, the euro has a negative impact on Germany’s competitiveness and “weakens the country’s banking system”. Most eurozone countries would “have gone bankrupt” long ago if the European Central Bank did not support them by lowering interest rates. “At the end of next year, Europe may face a dramatic decline in the availability of loans.” There will be massive bankruptcies of businesses, and the unemployment rate will soar. In an attempt to save the situation, the ECB will resort to emissions, which, in turn, will provoke a leap in inflation and “loss of savings not only of the Germans, but also of everyone who invested in euros.” The crisis in the European economy will undermine political support for the euro, “and countries will return to their national currencies.”  It sounds threatening, but let’s try to look at the details.

The slowdown of the German economy has been in place for several years. According to the returns of the year 2018, the GDP growth dropped to its lowest in the past 5 years and amounted to 1.5%, which is a decline of 0.7 compared to 2017. The largest EU economy “narrowly escaped a recession”. In the second quarter of this year, German GDP decreased by 0.1% against the same period the previous year; which, in annual terms, reduced the growth rate to 0.4%. Official forecasts for the results of the current year have been reduced to 0.5% – more than three times, compared with last year’s expectations. By early autumn, forecasts for a further decline in exports amid fears of a general slowdown in the global economy led to more expectations of a further slowdown of the economy.  The government of Angela Merkel, after expressing optimism about growth prospects for the current year, began to acknowledge the problem.

The economy of Germany is to a large extent dependent on exports, and any serious turmoil in international trade will cause Germany more damage than any other EU country. An important factor is the ongoing trade war between the United States and China, which is on the verge of a new escalation. What also creates a negative outlook for the entire European economy is the prospect of Brexit without an agreement between London and Brussels. Finally, the Chinese economy is slowing down, which has caused a decrease in demand for German export products, primarily cars. According to The Financial Times, in the first half of this year, the output in the car-manufacturing industry dropped by 12 percent. Also, the anti-Russian sanctions are hitting “the German farming sector and processing industries; German companies are losing jobs and profit,” – reports Gazeta.ru. Meanwhile, consumer spending and domestic investment continue to grow. Unemployment is at its lowest since the reunification of Germany. Reports of September 9 say that in July German exports rose again by 0.7%, rather than fall, as most observers had expected. Nevertheless, entrepreneurial confidence continues to decline in almost all sectors of the economy. Thus, the GDP growth rate in the 3rd quarter will make the key factor: in case of a decrease, we will be able to talk about a recession in Germany in the formal sense of the word.

Like most European banks, German comapnies have long been fighting a fierce battle to maintain the profitability of business amid the long-running period of ultra-low interest rates. Meanwhile, bond yields, especially long-term ones, continue to decline throughout Europe. The yield on German government bonds is negative for all securities with a validity term of up to 10 years inclusive. For 30-year bonds, the yield fluctuates around zero. The rate difference between short-and long-term borrowings – the main source of income for banks under normal conditions – is close to zero. As investors rush in search for safer assets, the forecasts are disappointing: negative rates will persist “for several more years.” Another negative prospect for the German banking system is the de facto negative rates on ECB deposits. In fact, banks have to pay the Central Bank for keeping their capital in its accounts. The prospect of a new drop in the ECB interest rate in the near future is causing more anxiety among investors.

The ECB is signaling its willingness to lower interest rates in order to neutralize the slowdown in the entire eurozone.  Experts predict that the ECB will either keep rates at the current low level or lower them even more, at least until mid-2020. In these conditions, the German government is likely to resort to tough measures to secure a deficit-free budget, at least in 2019. However, the policy of cutting the state debt could be revised. At the end of this summer, German Finance Ministry officials publicly spoke about a “package of economic incentives” that could be put into effect in the event of a recession in Germany. Depending on the extent of such stimuli, the balanced annual budget policy may be put at risk.

In 20 years, the euro has turned Germany into a key EU economy, critical for the economic stability of the entire union. At the same time, it has become a major factor that cemented the isolation of Germany in Europe. As skeptics had predicted, the admission to the eurozone, despite tough selection criteria, of countries very different from the economic point of view, led to the fact that a deterioration in the global economic situation hits the weakest member countries the hardest. According to critics, “the euro exchange rate is clearly too high for France and Italy (this becomes a blow to their competitiveness), and too low for Germany.” During the Eurozone crisis of 2009, there appeared a vicious circle: the dominance of the Federal Republic of Germany’s economy in the EU allowed Berlin to dictate its conditions for strict budgetary savings to most of Europe. This, in turn, gave rise to an outbreak of anti-German sentiment in a number of countries on the continent, including Greece and Italy.

By now, Central Europe has turned into a supplier of semi-finished products and spare parts for German enterprises. The rest of the EU countries are a market for German goods. Simultaneously, Germany is forced to pay for the economic failure of an increasing number of its partners in the eurozone. Thus, the economic power of Germany, while being the backbone of the entire economic system of the EU, has become almost the main threat to the European integration project. Even though the German economy boasts a significant amount of strength, “weak domestic credit performance, the risk of a global trade recession and the slowdown in China” will continue to “push” Germany to recession, – SaxoBank analysts quoted by Gazeta.ru said in the middle of the year. According to the June results, industrial production went down by 5% year-on-year. The ZEW economic sentiment index has reached its lowest level since December 2011. According to Eurostat, published in early September, the total GDP of the euro area countries grew by only 0.2 percent in the second quarter, which is two times lower against the first three months of this year.

In late August, The Economist made a prediciton that Germany would follow the path of Japan, which has been waging an incessant struggle against the threat of stagnation for decades. Like Japan, present-day Germany is rich, burdened with a large state debt, as well as an aging population. Trends in the German bond market also signal “endless stagnation.” Concerns are growing that politicians have “forever” lost their ability to improve the state of the economy. Moreover, the decline in consumer prices “pushes” discount rates yet lower. As a result, many experts believe that Berlin may be faced with the need for a more “self-oriented” policy, at least in the economic sphere.

Meanwhile, considering EU membership criteria, the majority of the eurozone member countries are in no position to take  any significant steps  in the event of a genuinely unfavorable turn in the global economic situation. The presence of the euro and the “unprecedentedly” high degree of independence of the ECB with its extensive powers put severe restrictions on the possibility of influencing the economy of individual states. In accordance with the current requirements of the eurozone, governments have to either increase taxes or reduce government spending – even if it harms the national economy. Formally, there is a monetary mechanism to counter economic upheavals in a particular eurozone country to minimize their consequences for other participants. From the point of view of abstract macroeconomic indicators, this mechanism has been functioning well up to now. But, judging by what we witnessed in Spain, and then in Greece and Italy, its socio-economic and political costs are extremely high.

Also, the ECB itself is pretty hard-up at the moment. In the spring, it extended the program of preferential lending to the banking sector. However, inflation is steadily below the 2 percent target, and interest rates, as mentioned above, are fluctuating around zero. The government bond retirement program, especially in the case of Germany, is already approaching the limit established by the current legislation. Given the situation, economists fear that in the event of a new economic shock, there may simply be “no room left” for monetary policy measures. According to pessimists, “Europe has already reached this point.” Thus, for the first time in the past decade, we can talk about the need to use fiscal stimuli. And it is completely unclear whether the decisions, which are likely to be the result of numerous political and bureaucratic compromises, will prove effective. Thus, the recently announced plans in the fiscal sphere of individual countries indicate, according to economists, the high probability of an increase in the eurozone budget deficit – up to 0.8 percent of its total GDP in 2019, The Economist reports. While the budget deficit keeps growing in Italy and France, Germany does not lose hope for a small economic growth in annual terms. In the absence of a common eurozone budget, “general” fiscal measures can again turn out to be only the arithmetic average of the diverse decisions taken at the national level. Optimists expect fiscal stimuli to add 0.2-0.3 percent to eurozone GDP growth by the end of this year. Yet again, much depends on Germany with its extremely significant “space for maneuver”.

However, Berlin is still in two minds about it, probably, because in the case of fiscal stimulus measures, consensus is important, along with a good coordination of actions of the governments of different countries. Only in this case could fears of stagnation disperse. Finally, the scope of necessary incentive measures requires a high degree of political credibility. Therefore, it cannot be ruled out that an economic recession in Germany could introduce substantial changes to the plans or dates of the transit of the supreme power scheduled for 2021. For Germany it took more than for other European countries to stop resisting the idea of fiscal stimulus for the economy. Now, observers argue whether the German authorities could go too far. In any case, they have yet to agree on such key parameters of the general budget of the eurozone as its size and permissible applications. Meanwhile, as pressure on the European economy keeps growing, a collapse of the eurozone can no longer be ruled out.

At present, there are still chances for Germany to avoid a recession, if not in the technical, then in the practical sense of the word. And even if it starts, the Federal Republic of Germany will enter it with one of the lowest unemployment rates among all countries of the world. By their nature, most factors that push the German economy “down” can be considered temporary. Nevertheless, more and more experts come to the conclusion that the economy of Germany “is balancing on the brink of recession.” The banking sector of Germany is busy struggling to maintain business amid zero or negative yield on assets, just like most banks in other countries of the euro area. Every day, it becomes clear that, in order to save the eurozone, the participating countries will have to make the difficult choice between delegating some part of fiscal sovereignty in favor of the hypothetical “common” supranational “finance ministry”, on the one hand,  and on the other, going on with their attempts, which are increasingly costly, if not utterly useless in the current conditions, to withstand cyclical fluctuations in the economy with the help of the ECB monetary measures alone. 

From our partner International Affairs

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Digital Economy Development in China Shifts the Focus to the Production Side

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Just recently, China’s Central Commission for Comprehensively Deepening Reform reviewed various plans for data system, including a guideline on building the basic systems for data and making better use of data resources. The central government’s layout from the construction of the basic system of data is intended to lay a solid foundation for the further development of the digital economy, in addition to pushing for the development of the data-based data industry to further accumulate resources and driving force. These new changes in the digital economy signify that there is the establishment and improvement of rules in the digital economy of China.

Looking at the content of the guidelines and plans, there are two aspects worth noting, the first is to clarify the ownership and classification of data, and the second is to build a mechanism for data transactions. The clarification of the ownership and the rights and responsibilities is crucial in establishing the legal foundation for data transactions. Of course, the new plan has yet to clarify this, but it does present the hope to develop a system with clear ownership so that the corresponding data transactions can be carried out. Although Shanghai, Beijing, Hainan, and other places have begun the attempt of creating data exchanges and data transactions, in terms of scale and transaction frequency, this is still in the initial trial stage. Researchers at ANBOUND believe that the focus of data resource development and application of digitalization will shift from the consumer side to the production side.

While the new concept provides a framework for the establishment of the data system, it does not mean short-term boost for the development of the data industry or the digital economy can be formed. The future relies on digital technology to generate data, rather than monetize data, and the same is true in other fields. With this, the model of harvesting from online traffic flow by capital and market expansion will face higher and higher business costs and regulatory barriers. Judging from the development trend of the digital economy in China, after the rectification of internet platforms and the country’s domestic 5G network reaching the stage of large-scale popularization, the overall driving force for the development of the digital economy will be weakened.

Statistics reveal that in 2020, the scale of China’s digital economy has reached USD 5.4 trillion, accounting for 38.6% of GDP, maintaining a high growth rate of 9.7% and becoming the key driving force for stable economic growth. Yet, the growth rate still dropped by 5.9 percentage points from the previous year. The downward trend in the growth rate of the digital economy deserves attention. In 2021, the expected growth of the digital economy scale was RMB 42.4 trillion, accounting for 37.06%, a slight decline from the previous year. At the same time, the proportion of China’s digital economy in GDP was 21.4 percentage points lower than that of the United States, Germany, and the United Kingdom, and 5.1 percentage points lower than the global average.

Researchers at ANBOUND pointed out that the main problem that needs to be solved in the future development of China’s digital economy is the ownership of data resources. The main issue being disputed in the country’s traffic economy that is constraining internet platforms is precisely about the right to data usage. In the existing internet platform economy like online consumption, when the market expansion encounters boundaries and the cost of data acquisition is getting higher and higher, internet platforms that rely on their own accumulated customer data are seeking to realize cash in consumption and finance. This has brought a great impact on the current real economy and financial sectors, and is also an important cause of the authority’s rectification of internet platforms. As noted by ANBOUND, clarifying and resolving the matter in regard to the ownership of data resources is becoming a pragmatic issue. As far as data resources are concerned, although there is still some room for development in the medical and financial fields, under the background of the increasingly perfect anti-monopoly system and the continuous improvement of supervision, the traffic economy is now being constrained and restricted. This signifies that the space for the application and development of the existing large amount of data resources based on consumer data will be constrained on the consumer end.

From the overall trend, when the internet platform is constrained and the traffic economy encounters incremental bottlenecks, the development of digital industrialization dominated by terminal digital consumption will face difficulties in transformation after going through a stage of rapid growth. Looking at the data industry, on the one hand, strengthening supervision means that the Big Data resources, mainly consumer data, also face institutional obstacles to further development and “diversion”. The development of digital industrialization not only faces the obstacles of insufficient digital infrastructure, but also requires technological breakthroughs in its industrialization development itself. In addition, the production side also faces the basic hurdle of lack of a large amount of production data. Therefore, in the new growth space of the digital economy, the demand for large amounts of data on the production side will be the key driving force for building a basic data system and establishing a data transaction mechanism.

The central and western regions of China are building data centers to meet the current and future needs for large amounts of data storage. However, the application of these data and the development of data resources not only face basic systemic problems, but also lack the development of data application fields. In Guiyang, known for its development of the Big Data industry, the focus is chiefly on storage, and the Big Data investment projects there are mainly on the data centers. To mine data resources, it is not only necessary to realize the accumulation and mining of data, this also requires the support of technology and industry to realize the appreciation of data through digital technology. However, the weak real economy and lack of data development capabilities have become the biggest shortcoming of Guiyang’s development. This makes its data industry generally at the middle and low end of the value chain, and its core competitiveness is rather weak. If the Big Data industry in various places wishes to assume further roles, it still needs the upgrading and integrated development of basic industries. The future development of the data industry depends on the accumulation, application, and development of a large amount of production data. This also means that the future focus of the development of the digital economy begins to shift from the consumer side to the production side.

Final analysis conclusion:

The Central Commission for Comprehensively Deepening Reform’s conception of the construction of data infrastructure means that it will solve the fuzzy area of data ownership and further realize the tradability and transfer of data. This provides an institutional and market foundation for large-scale data development. The digital industrialization of the consumer side, as things stand, has come to an end, where the growth focus of the digital economy will shift to the production side.

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Economic Sanctions As An Act Of War

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The outbreak of the Russo-Ukraine war in 2022 saw the imposition of one of the most comprehensive international economic sanctions on any country in history. These sanctions were expressly aimed to damage the Russian economy, pressure its population and force its leaders to cease hostilities against Ukraine. These measures caused a run on banks, an economic recession and sky-high inflation in Russia. In response, Russia imposed retaliatory sanctions of its own and, described the Western sanctions as an ‘Act of War’. North Korea had raised a similar contention in 2017 in response to similar sanctions.  This author seeks to focus on and examine this claim on its merits and normative value in International Law.

I argue that, from an effects-based perspective, comprehensive and long-term economic sanctions should be regarded as an ‘Act of War’. In a globalised world, economic sanctions can have a disproportionate and indiscriminate effect on a nation’s populace, comparable to that of a direct military intervention in the form of a blockade. The decision to impose economic sanctions should thus ideally be regarded as such and be subjected to the same level of scrutiny and qualifications such as what the case for an armed intervention to be legitimate in modern International Law. A calibrated standard to determine a ‘legal’ economic sanction not amounting to an act of war, will allow for proportionate use of sanctions, to minimise their human costs and respect the rights of economically weaker states.

Economic Sanctions in International Law

The term ‘sanction’ in international law refers to a peaceful action, usually responding to a breach of an international law principle and aiming to economically constrain a target state, entity or individual , imposed by a state or authority with the legal capacity to do so.  Sanctions may be comprehensive, such as completely prohibiting commercial activity with an entire country, or they may be targeted, blocking specific types of transactions, with specific entities or individuals.

Sanctions act as tools of coercion aimed to cause popular dissatisfaction and create pressure on a country’s leadership to change its foreign policies. Importantly, sanctions imposed by major powers such as the US and EU, include ‘Secondary Sanctions’. Such sanctions extend similar trade restrictions to any other third country which continues to deal in the restricted trade with the target country. Secondary sanctions reduce the alternative trade partners for a target country and magnify the effects of sanctions.

The UN Charter itself, in Art. 41, mentions the use of economic sanctions as a measure by the Security Council to give effect to its decisions. It clearly treats it as a separate, less egregious measure then the use of armed force provided for in Art.42. ‘Blockades’ are also mentioned separately as within the scope of use of armed force by the Security Council.

The UN framework does not provide the only legal basis for states to impose economic sanctions, as states are relatively free in customary international law to adopt unilateral sanctions against states, entities and individuals. Various regional treaties also allow for use of collective economic sanctions.

It is also important to acknowledge a long-running movement in the UN to delegitimatize use of unilateral economic measures as a method of coercion, recognising that such measures significantly disadvantage developing countries in particular. This movement has manifested itself in form of various General Assembly resolutions such as Resolution 2131, ‘Declaration on the Inadmissibility of Intervention in the Domestic Affairs of States and the Protection of Their Independence and Sovereignty’, 1965; Resolution 2625 (XXV), ‘Declaration on Principles of International Law concerning Friendly Relations and Cooperation among States in Accordance with the Charter of the United Nations’, 1970;   

However, such resolutions are non-binding in nature. As it stands, a strict reading of the UN Charter and associated international legal instruments, does not per se allow for regarding economic sanctions as an act of war, as will be elaborated below.

Economic Sanctions as an ‘Act of War’

Defining ‘Act of War’

Art. 2(4) of the UN Charter prohibits all UN members from resorting to the threat or use of force, against the territorial integrity or political independence of any State. However, Art. 51 allows for use of force authorised by the UN Security Council, or in the exercise of the rights of individual or collective self-defence. The word “force” in this context was initially generally understood to refer only to military force. “Acts of War” are thus restricted by international law. General Assembly Resolution 3314, passed in 1974, also sought to define ‘acts of aggression’, but excluded ‘economic aggression’ from the ambit of the resolution.

Comparison to Blockade

The closest ‘act of war’ that may be ‘analogous’ to a comprehensive economic sanction may be the act of a ‘blockade’. A ‘blockade’ is an act of war which involves restricting ships or aircrafts of some or all nations from entering or existing specific ports or coastal areas of a target country, by the threat or use of armed force. Such an act aims to degrade a country’s economy and affect its populace by preventing trade and movement of essential goods. It is included as an act of aggression in Resolution 3314 and also mentioned in Art. 42 of the UN Charter as a type of armed force that may be used by the Security Council.

A sanctioning country uses legal barriers to restrict its trade with a target country and also usually uses its economic heft to dissuade other countries from trading with a target country, by threatening to sanction them too. The question that arises is that how is this situation, from an effects-based perspective, different from a comprehensive economic sanction?  If the net result is the same, that the country’s trade is restricted and its populace is deprived of essential goods, why should only a physical blockade be regarded as an act of war and be subject to stricter scrutiny. This similarity of effects can be proved empirically using historical instances of comprehensive sanctions.

Comprehensive economic sanctions cut off a country from the global financial system, block foreign investment and remittances, cause loss of employment in export industries, causes shortage of essential import goods and high-end technology, which has ripple effects on the economy and popular welfare. These effects are particular amplified for a smaller, developing country which is less likely to be self-sufficient in essential goods.

Various case studies by Prof. Joy Gordon of use of sanctions in Iran, Iraq, and Cuba, demonstrate the damaging effects of sanctions on a country’s economy and tangible loss of life and popular welfare, easily comparable to a devastating armed conflict. For instance, the sanctions regime in Iraq resulted in the deaths of an estimated 500,000 civilians, exceeding the casualties in the Gulf War that followed. The sanctions had included restrictions on import of food grains and import of essential ‘dual use’ goods such as fertilizers for agriculture and chlorine for water purification, which resulted in a famine, epidemic and rise in infant mortality.

Addressing Counter-Arguments

Exercise of State Sovereignty

The first probable argument against treating economic sanctions as an act of war, would be based on state sovereignty, namely the right of a state to dictate its own trade policy. This principle was affirmed in Republic of Nicaragua v. The United States of America, 1986 I.C.J. 14, with specific reference to trade relations— that in the absence of a treaty commitment or other specific legal obligation, a state is not bound to continue particular trade relations longer than it sees fit to do so. States may thus argue that they have the right to choose their trade partners and treating these decisions as an act of war, would make them contingent to UNSC approval and abrogate their economic independence. 

However, state sovereignty is not an absolute principle, especially when pitted against humanitarian interests and interests of other states. The above argument may be addressed by a more careful calibration of standards on what kind of sanctions may amount to an act of war. A probable standard could be considering only those comprehensive economic sanctions which are imposed on essential goods, a shortage of which endanger the basic human rights (such as those to food, clean water, medication etc) of the citizens of the recipient state. This would amount to a reasonable restriction on the right of a trade of a sovereign country, namely that it should not wilfully endanger the essential rights of civilians of another country.

It is also essential to note that the existing regime of economic sanctions can also be differently viewed as a restriction on state sovereignty, as countries with disproportionate economic power are able to use ‘secondary sanctions’ to force other states to comply with sanctions on a target country. This also derogates sovereignty of other states by limiting their trade with a target country.

Economic Sanctions as a ‘Soft Tool’

It may also be argued that treating economic sanctions may deprive countries of an essential ‘soft’ tool to influence ‘rogue’ states and uphold the international legal order, without crossing the threshold of armed conflict.

However, a calibrated standard, as described above, would not completely preclude the use of economic sanctions. Countries may continue to use targeted economic sanctions against the political and economic leadership of a rogue state such as restricting their movement, seizing their overseas assets and crippling their businesses to exert pressure. Military and non-essential goods may continue to be restricted completely. In fact, recent studies have demonstrated the comparative effectiveness of targeted sanctions to influence state policy, as compared to general sanctions, with reduced human cost on the powerless sections of the society of the target country.

Moreover, even in this proposed model, comprehensive economic sanctions may be employed, if necessary, with the approval of the UN Security Council, which still has the authority to exercise use of force, under the UN Charter.

Conclusion

In summary, it is clear from an effects-based perspective, that comprehensive economic sanctions are comparable to direct military intervention such as a blockade.  Economic sanctions should thus be brought into the ambit of an act of war, and international legal safeguards on use of force should be applied.

A calibrated standard to determine a ‘legal’ economic sanction not amounting to an act of war, would allow the use of sanctions in a regulated, proportionate manner, to minimise their human costs and respect the rights of economically weaker states.

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Yen Becomes the Next Eye of the Storm in the International Capital Market

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With the recent acceleration of interest rate hikes of the Federal Reserve, the yen is under increasing pressure while the U.S. dollar index remains high. This, in turn, causes the Japanese currency to show a trend of continuous depreciation. The exchange rate of the yen against the U.S. dollar broke through the key node of JPY 135, reaching a high of JPY 136 on June 21. On June 23, USD/JPY continued to hover around a 24-year high of 136. Earlier this week, at one point, the exchange rate of the dollar against the yen reached the highest since October 1998 to JPY 136.70.

Since the beginning of this year, the yen has depreciated by more than 18% against the dollar, and its depreciation rate ranks among the top among the G10 countries. The changes brought about by the devaluation of the yen have greatly changed its role as a traditional safe-haven currency, and it has increasingly become the center of focus for speculation.

With the continuous depreciation of the yen, Japanese government bonds have also shown a gradual downward trend, and have repeatedly exceeded the 0.25% yield ceiling of the Bank of Japan (BOJ)’s yield curve control (YCC). Although the BOJ has repeatedly increased its purchases to maintain the yield of the bonds, this is still insufficient to help the currency exchange rate at the same time. Consequently, the current speculative attack on the yen and Japanese government bonds has become an opportunity that hedge funds are keen on. Indeed, the market has been paying attention to such speculation on the BOJ in the bond market. Although the central bank has implemented the strategy of unlimited purchases of Japanese government bonds since March to drive down long-term interest rates, the market is still skeptical that it can hold the bottom line, hence the commencement of the so-called “widow-maker”.

The main reason for such a situation is the widening of the monetary policy gap between the United States and the BOJ. As the Fed began to tighten monetary policy, simultaneously raising interest rates and shrinking its balance sheet, the BOJ still adhered to the quantitative easing policy, which is one of the “three arrows” of Abenomics. On the one hand, it maintains negative interest rates, and on the other hand, it continues to inject yen liquidity into the market by purchasing yen assets. However, with the recent rise in global inflation, Japan’s inflation has achieved the 2% target that has been difficult to achieve for many years. In April this year, Japan’s inflation rate reached 2%, with the core inflation rate being 2.1%. Driven by the depreciation of the yen and rising international energy prices, the country’s inflation may reach 2.5% in May, and the core inflation will remain at the level of 2.1%. This is arguably the achievement of the BOJ’s policy goals for many years. However, the achievement of this target is largely dependent on the depreciation of the Japanese currency, rather than the increase in demand. Under the pressure of inflationary pressure brought about by the depreciation of the yen and the rising yield of Japanese government bonds, whether the BOJ can adjust its policy and whether it can maintain the strategy of yield curve control is the key concern for the market institutions. Some analysts believe that when other central banks abroad are making a choice between economic growth and controlling inflation, the BOJ has to face a choice between the yen and Japanese bonds.

Japanese Prime Minister Fumio Kishida and the BOJ Governor Haruhiko Kuroda have both stated that they do not want the sharp depreciation of the yen to continue and will pay attention to the trend of the foreign exchange market. That being said, there is no perceivable specific action to intervene in the market, and the market could very well let the yen depreciate. The depreciation of the yen has always been considered positive for the Japanese economy and its stock market, while Abenomics also saw it as a key means to boost inflation and stimulate the economy. Nonetheless, many institutions and scholars have repeatedly pointed out that the situation this year has been very different from the beginning of Abenomics. The damage to the Japanese economy caused by inflation and the depreciation of the yen is far greater than the gain. In the past two years, both the Japanese economy and the Nikkei have been “decoupling” from the trend of the yen. Economist Nouriel Roubini, touted as “Dr. Doom”, recently warned that if the yen exchange rate falls further to 140, it will bring serious inflation problems to the BOJ, and the central bank will be forced to make policy adjustments, abandoning aggressive monetary policies such as zero interest rates and YCC. This means that the BOJ’s policy shift has come under increasing pressure, and is being anticipated and bet on by more and more markets. This has turned the yen from a safe-haven currency to the eye of the storm, so to speak, in the current market game.

Yet, if the Japanese central bank abandons the quantitative easing policy that has been implemented for years, there will also be huge impact on the market. Some analysts opine that the YCC of the BOJ is the last anchor of the old global yield curve structure that utilizes arbitrage conditions, as well as the liquidity of the dollar and yen. If this is dismantled, the impact will be global, and it will place even more pressure on bond yields in the United States, Europe, and Asia. On the Asian side, the South Korean won, the Philippine peso, the Hong Kong dollar, and the Chinese yuan are also under pressure from rising bond yields and currency depreciation. If the BOJ’s policy changes, the consequences will be so terrifying that it may very well be the last straw to bringing down the global capital market.

Final analysis conclusion:

With the widening policy differences between the Federal Reserve and the Bank of Japan, as well as with the rising inflation in Japan, the yen continues to depreciate. This has turned it from a traditionally safe-haven currency into the eye of the storm within the international capital market. The game between the market and the BOJ has caused the Japanese central bank’s future policy choice to become a global focus. Regardless of what the outcome might be, it will certainly have a huge impact on the market.

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