Japan Announces Purchase of European Bonds

By: Keith Weiner | Thu, Jan 10, 2013
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Japan will by the bonds of the so-called "European Stability Mechanism". (See Bloomberg article, Japan to Buy European Debt With Currency Reserves to Weaken Yen)

The ESM is an 80 billion euro pool of capital that can be levered up to 700 billion euros by selling bonds. Supposedly, 200 billion has to be kept safe but that remains to be seen. The ESM is a mechanism to lend more money to insolvent governments whose problem is too much debt. These governments borrowed too much. Therefore someone lent them too much.

ESM will lend them even more.

ESM is a misnomer, as it is merely a temporary extension of the unsustainable borrow-to-spend status quo. Lending a broke government more money so they can lend it to broke banks and dole it out to the unions and welfare programs will not stabilize anything. Eventually, the insolvent debtor countries will default on their debts to ESM. The consequence will be losses for the European governments that contributed the 80 billion and losses for the buyers of ESM bonds.

What does Japan hope to get by doing this? According to Japanese Finance Minister Taro Aso, Japan "seeks to weaken its currency". The Europeans are wary of Japan acting to weaken the yen, and by this move Japan may be throwing them a bone. It would be hard for Europe to criticize Japan for buying ESM bonds. In order to weaken its currency, Japan will be throwing away the money of its taxpayers by buying bonds to help Europe lend to its insolvent but profligate socialist governments. It will be inflicting terrible losses on its savers, whose wealth will be diminished as the yen declines.

The Bloomberg article does not say what would motivate a government to enact such a hurtful policy, though it does hint that the insanity is worldwide. "He [Aso] also questioned whether major Group of 20 nations had stuck to pledges from 2009 to avoid competitive currency devaluations."

Why would a major country have to pledge not to hurt its own people, especially savers and productive businesses? Why would anyone think that, having made such a pledge, it might really be shooting itself in the foot? Why would anyone think that there might be 20 .357 revolvers blazing away?

The worldwide regime of irredeemable paper money provides the means for each country to shoot themselves in the foot. Each currency has a value in terms of all the others, but none of them are anchored in reality. No one has the right to redeem paper in gold or anything else. Therefore the real value of a paper currency is arbitrary. A dollar might be able to buy a steak dinner for four people, or it might be able to buy a stick of chewing gum. Its value is arbitrary. Governments have the power to reduce the value of their paper currencies, and they have being using this power for a long time.

The old fallacy of mercantilism provides the motive. Currency debasement is proposed as the cure for unemployment and falling exports. Pushing down the value of the currency is purported to solve the problems of rising costs, perverse regulations, high taxes, and declining competitiveness. Even Milton Friedman believed that a country could compensate for an ill-considered minimum wage law by currency debasement. Here is a quote from The Case for Flexible Exchange Rates by Milton Friedman in 1953:

"The argument for a flexible exchange rate is, strange to say, very nearly identical with the argument for daylight savings time. Isn't it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely, the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure."

Another reason for the pervasive desire for a falling currency is the old ideology of mercantilism, which favors exports for the explicit policy goal of running a trade surplus.

A falling currency will not allow a country to get away with shackling its productive enterprise with onerous regulations, sapping its vitality with confiscatory taxation, and burdening it with a workforce that is underpaid, inflexible, unmotivated, and underproductive. Before a country can export a good, it must produce the good. Before a worker can be paid, there must be capital accumulation that enables the productivity from which to pay him. A falling currency undermines productivity by destroying the capital of productive businesses and draining it from savers before it can be invested in new productive enterprises. There is also another problem, know as the "terms of trade" (see my paper for a discussion: http://keithweiner.posterous.com/floating-exchange-rates-unworkable-and-dishon ).

There is one other problem with the idea that a country should debase its currency to fix its problems. If all countries attempt it at the same time, then all may lose value (against gold) but the ratios between the currencies may not change much.

Typically, people do not study the intellectuals who originate and promote the ideas they believe. Especially when an idea becomes "generally accepted", everyone takes it for granted. Nearly everyone today, including many who claim to be of the "Austrian School", accepts the assertion that a falling currency will help a country and specifically grow exports and employment.

It is time that the world rediscovers that nothing good can come out of destruction. Would it help people to understand this if we call it the "broken dollar fallacy"?



Keith Weiner

Author: Keith Weiner

Keith Weiner

Keith Weiner

Keith Weiner is CEO of Monetary Metals, a precious metals fund company in Scottsdale, Arizona. He is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. He is founder of DiamondWare, a software company sold to Nortel in 2008, and he currently serves as president of the Gold Standard Institute USA.

Weiner attended university at Rensselaer Polytechnic Institute, and earned his PhD at the New Austrian School of Economics. He blogs about gold and the dollar, and his articles appear on Zero Hedge, Kitco, and other leading sites. As a leading authority and advocate for rational monetary policy, he has appeared on financial television, The Peter Schiff Show and as a speaker at FreedomFest. He lives with his wife near Phoenix, Arizona.

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