" The strong yen is puzzling for the many forecasters who had expected a cheaper yen. Traditional theories indicated weakness: Interest rates in Japan are the lowest in the world and still falling. In August, the call rate more than halved, dropping from 0.0025 percent to 0.001 percent. Many commentators read the official publications of the Bank of Japan and noticed that the central bank had increased its outright bond purchases, was buying record amounts of stocks and was boosting bank reserves to a record Y30 trillion. As a result, high-powered money (cash in circulation and bank reserves with the central bank) has been growing rapidly. The central bank also introduced a new type of transaction with much fanfare: asset-backed securities purchases. According to the Financial Times, the Bank of Japan is flooding the markets with money. With so many banknotes being printed, surely the currency should weaken.
But it rose. There are two possibilities: Either the yen-dollar exchange rate is wrong, or our reading of the facts is. Since the yen-dollar foreign exchange market is the most liquid market in the world, we had better check our facts. Could it be that the information about the Bank of Japan flooding the markets with money is only part of the story and that we are missing something?
The question is: Does the Bank of Japan also engage in transactions other than those highlighted in its public statements? It may be news to some, but apart from the purchase operations making the headlines, the Bank of Japan has also been conducting sizeable, though less publicized sales operations, which withdraw money from the economy. What good does it do the economy, if outright bond purchases are rising, but sales of commercial paper are rising more?
What good is record foreign exchange market intervention, if it is not only completely sterilized, but over-sterilized by the central bank, just as in early 1995 and 1999? Calculating the central bank's net credit creation, we find that the Bank of Japan has been steadily reducing its money injections into the economy for the past year. This policy did not change with the arrival of the current governor.
The relevance of our measure of net Bank of Japan credit creation can easily be tested by examining its link to the yen-dollar rate. There is a close correlation between relative central bank credit creation and exchange rates. Since net Federal Reserve Bank credit creation in the United States has been steady, but Bank of Japan credit creation has been falling, at the Profit Research Center Ltd. we had advised our clients as early as March this year to purchase yen. It was not likely to weaken, we argued, but to strengthen
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