FX Doctor, Analyst on Demand Host
It is pronounced Kuroda. The chairman of the Bank of Japan (Mr. Kuroda), announced Wednesday (Thursday in Japan) that he would be taking a page out of U.S. Federal Reserve Chairman Ben Bernanke’s play book to help rescue Japan’s failing economy. The term used to describe the strategy is quantitative easing (Scary!). Mr. Kuroda’s kindred spirit, Mr. Bernanke, used this strategy in the darkest days of the U.S. economy. Banks were going out of business, home values were down, and businesses were defaulting on loans in ways unseen since the Great Depression. From Mr. Bernanke’s viewpoint, the problems with the economy could start to unwind themselves if the banks would just start lending to small businesses again. Due to the weight on the U.S. economy, the banks had tightened their lending standards to the point that they were not making any loans at all. Without capital, businesses, especially small businesses, were failing in huge numbers. So, how did the bearded one intend to fix the problem? Quantitative Easing! (There’s that word again!)
Companies, banks, municipalities and other high-stake enterprises often raise capital through the sale of bonds. For those unfamiliar with the difference between stocks and bonds, the difference is this, when an investor buys a share of stock, he or she is actually buying partial ownership of a company. His or her reward comes as the value of the company increases. An investor who purchases a bond is not buying ownership; instead he or she is loaning the company money for operating capital. This bond holder (investor) agrees to loan this money to the company in exchange for interest payments over a defined period of time and the guarantee that the original lump sum loaned will be repaid on a specified date. Quantitative easing is the strategy by which the Federal Reserve agrees to flood the market with cash by agreeing to buy bonds. No middle man exists here. It is like a child asking his parents for money. They just dig into their pockets and pull out a wad of cash and ask, “How much do you need?” The people printing the money are now becoming creditors. The Federal Reserve also agrees to keep the interest rate required for the bond payback at an extreme low. Are you starting to get the picture? Mr. Bernanke, and now Mr. Kuroda, are flooding the markets with practically free money. The intention is that if banks can borrow from the Federal Reserve at one percent interest rate, and loan that money to businesses at a five percent interest rate then they could make a healthy profit. Banks would be happy. The people who need the money would be happy. And, everyone lives happily ever after.
Unfortunately, the first time Mr. Bernanke tried this, the banks did not get the memo that they were supposed to use the cheap money to lend it out to businesses that needed it. They sat on it and padded their books. The money did not get to where it needed to go. When this announcement was made by Mr. Kuroda, the value of the Japanese yen tanked, just as the U.S. dollar did when Mr. Bernanke announced the “QE” (not as scary when you say it this way) in the U.S. Why? Because the value of that country’s money decreases when there is more of it and it is being lent out for less. Hopefully, this page out of Mr. Bernanke’s playbook won’t just make the Japanese banks rich, but stabilizes the Japanese economy as well.
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FX Doctor, Analyst on Demand Host