Japan Goes Shopping for Inflation

10/07/2010 10:30 am EST

Focus: GLOBAL

Igor Greenwald

Chief Investment Strategist, MLP Profits

It was a shot heard around the world, fired by the unlikeliest of combatants. The gradualist pacifists at the Bank of Japan pulled the trigger under extreme duress, pressured by politicians who are in turn feeling the heat from voters desperate for someone, anyone to do something, anything.

The central bank set off for war against persistent economic rot by announcing plans to eventually acquire a popgun. But at least it’s been dragooned into a new campaign, and there’s no telling where this arms race will end up.

The $60-billion fund the bank will “examine establishing” to buy up (mostly) government and corporate debt but also possibly equity and real estate proxies isn’t all that much: As has been pointed out, the Bank of England has spent more than five times that amount to prop up an economy less than half as large. But as a down payment, it sufficed. So did the central bank’s pledge to keep short-term rates at zero until deflation has been licked once and for all, even though the 1% inflation it is now effectively targeting hardly seems like a sufficient cushion.

None of it might have mattered beyond Japan’s shores had the bank been acting in a vacuum. Instead, members of the US Federal Reserve have been telegraphing another bond-buying program of their own. The QE2, as the Fed’s second round of “quantitative easing” has become known, may proceed as ponderously as an ocean liner and prove about as nimble. But the knowledge that it’s in the wings has generated notable interest in financial assets.

Unfortunately for the Fed and for Japan, the assets generating the most interest reside overseas or else in commodity warehouses. This makes the quantitative easing look like a salvo in a trade war to countries like Brazil with a strong economy, higher interest rates, and a rapidly appreciating currency. Brazil has just doubled the tax on foreign purchases of local bonds to 4%. Other fast-growing exporters will also be tempted to use curbs to limit inflows of cheap Western money.

Critics abound left and right. More than one dissenter at the Fed has opposed quantitative easing on the grounds that it won’t accomplish much. Nobel laureate Joseph Stiglitz agrees, though his preferred solution of additional fiscal stimulus doesn’t seem to be in the cards. Financier George Soros also doesn’t think that monetary easing will be effective in the absence of a spending boost. He’s warning that Germany’s insistence on fiscal austerity in Europe could prove disastrous. 

At least the European Central Bank is still buyinga Irish bonds, and someone out there is even making money on Greek ones.

Financial markets weathered the latest credit downgrade of Ireland without breaking a sweat. But the austerity required to bail out the country’s banks is prolonging a painful recession.

In contrast, East Asian economies and stock markets are on an epic run as minimal interest rates in the US, Europe, and Japan spark a global scavenger hunt for growth. Gregory Weldon argues that hot markets like Indonesia and the Philippines are far from done, especially now that Chinese satellites Hong Kong and Taiwan are piling on.

Fund manager Andrew Sleeman hopes to take advantage of the commodity boom by investing in several underappreciated Australian stocks. He’s also partial to select European insurers and one unusual Japanese bank. The strategy of collecting a decent dividend while waiting for a takeover bid or better business has a lot going for it these days.

With oil prices on the march, the payoff rises for a North Sea explorer that’s already experienced a fair bit of success, according to John Snowden. And for the Chinese solar plays highlighted by Timothy Lutts and Brandon Coffey, the payoff has already been enormous. Yet on the basis of their price-to-earnings ratios and likely growth, they’re still quite cheap. Don’t wait for QE2 to prove that point.

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