* Forwarded (from: netmail) by Roy J. Tellason using timEd 1.10.y2k.

More about the way "the state" tries to increase their power over
us serfs by playing games with the money we all use...

From: Gary North & The Daily Reckoning 
Subject: The Monetization of Equity

Gary North's REALITY CHECK

Issue 197                                 December 12, 2002

THE MONETIZATION OF EQUITY

It has finally happened.  The Bank of Japan, Japan's central bank, has
begun purchasing stocks held by the nation's commercial banks.  The BoJ
creates digital money to buy the shares.  The shares now in the BoJ's
possession serve as legal reserves for the expansion of Japan's money
supply.

This has begun to move the monetary system from credit money to pure fiat
money.  The ability of the central bank to expand the money supply will no
longer be limited by people's willingness to borrow.  Now the only limit
will be the willingness of sellers to sell.  In a time of economic slowdown
and a premium on cash, there are few limits on hard-pressed sellers'
willingness to sell.

The first effect of this increase in the money supply is this: commercial
banks will spend the money they have received from the BoJ.  Money created
is money spent. Money does not sit idle in any bank's account.  Banks make
money by lending money or by buying assets, such as government debt.  If an
low-risk asset pays anything above zero, the bank will buy it if there is
no better
opportunity.  Better something than nothing; better a little income than no income.

When the bank buys an asset from someone, the asset's seller becomes the
owner of newly created money.  He spends it or invests it or deposits it in
his bank.  So, the money is passed from buyers to sellers.  It will stay in
circulation.  It will remain in someone's bank account.

The second thing that happens when the BoJ purchases equity is that the
commercial bank gets rid of a depreciating asset, or a high-risk asset, and
transfers it to the BoJ.

Japanese banks are unable to meet the capital requirements that were
imposed in 1988 at the Basle Accord. The richest nations, known
collectively as the G-10 nations, agreed to higher capital requirements for
their commercial banks.  This was a year before the Japanese economy
peaked.  Japanese banks are allowed to use the value of stocks in their
portfolio to count as part of
their capital requirements.  The Japanese stock market was a bubble in
1988.  The shares were rising.  Japanese banks had money to lend because
their capital looked secure.

(RJT:  I wonder if these "accords" would fall under the RICO statutes?  :-)

Beginning in January, 1990, the Japanese stock market started down.  It has
never again approached the December, 1989 high.  Bank capital therefore
began to shrink at the same time that poor real estate loans ceased to
produce interest income.  Japan has never been able to meet the Basle
Accord's timetable.  But Japan is too big to fail. There is no way for the
other nations to impose meaningful sanctions on Japan for not enforcing the
Basle Accord.

Over 100 countries have formally adopted the terms of the Accord. 
Predictably, only a handful of them have actually met the Accord's
requirements, which are restrictive in the expansion of money in a
fractional
reserve banking system.  When banks slow their lending because they have
hit legal restrictions in the form of capital requirements, economies that
have been growing cease growing.  This is politically unacceptable to
politicians and central bankers.

Policy-makers want the benefits of a pure gold coin standard -- stable
prices, no boom-bust cycle -- but without the political restrictions of a
gold standard: public control over the money supply through bank runs in
gold coins, the inability of governments to sell lots of new bonds to banks
without raising interest rates, and economic growth determined exclusively
by factors in a free market.  A gold coin standard is the mark of
decentralized control by individuals over the economy.  Politicians and
central bankers resist this development.

So, we see the authorities on a tightrope.  They do their best to avoid
mass inflation, but they also want to avoid deflation and recession.  Their
prior policies of monetary expansion created a politically popular economic
boom.  New policies designed to keep prices from rising threaten to stop
the boom.

(RJT:  They also want inflation to continue.  Seems to me that when I was a
kid it was so small as to be unheard of,  and in those days it made sense
for people to put money in a savings account -- you could earn a few
percent interest,  and get ahead of things.  But not any more.  By keeping
inflation going,  though,  at what they'd consider "acceptable"
levels,  they keep people creeping into ever-higher tax brackets, 
increasing their revenues,  and not ever have to change any of the
legislation that authorized this stuff in the first place.)

THE SITUATION IN JAPAN

In Japan, the economic boom stopped in 1990 and has never reappeared. 
Japan's commercial banks have been trapped in a tightening noose.  Their
Basle-imposed capital requirements have risen at the same time that the
market value of their capital has been falling: bad real estate loans,
falling share prices, and bad industrial loans.

This has led to a refusal of the commercial banks to lend to innovative
small companies, which are the basis of most economic growth.  These
companies find it difficult to sell shares because of the normal regulatory
process, but also because of falling share prices.  The result has been a
lack of economic growth.  The Japanese economy has been staggering for over
a decade.  It gives few indications that it is ready to rebound.

Japan's aging public has lost faith in the system. Voters are not agreed on
what needs to be reformed, so the government changes nothing of substance. 
It just does more of the same.  It spends more money.  It runs large
deficits.  The debt burden per capita rises continually.

Japan has become the world's strongest piece of evidence that the Keynesian
policy of economic growth through deficit spending does not work well.  The
Japanese economy does not recover despite 13 years of deficits.

The central bank has expanded the money supply in order to keep the general
price level from falling.  It has reduced short-term interest rates almost
to zero.  Still, the economy refuses to improve.  The stock market
continues to fall.  The nation's investors, which includes the commercial
banks, have lost faith that the stock market will ever return to its 1989
level.

All politicians fear price deflation, which is regarded as the chief mark
of recession.  Debts that were voluntarily contracted when prices in
general were higher become an increasing burden on debtors when prices
fall, i.e., when the value of money increases.

The other side of the coin is also true.  When prices in general fall, this
is good news for creditors, who experience a windfall profit: rising real
income.  But there is a politically inescapable rule: don't alienate
debtors.  Politicians understand this rule and follow it: "There are
more debtors who vote than creditors who vote." It is a political
liability to be an incumbent when prices in general are falling, unless the
fall in prices is being produced by rising output.  Even then, there are
political liabilities.  Debtors want a return to the good old days of
rising prices, thus enabling them to pay off their debts less expensively. 
They vote for politicians who promise them depreciating money.

Officials with the Ministry of Finance, an agency of the government,
recently called on the Bank of Japan to increase the money supply enough to
create at least 3% price increases per year.  THE JAPAN TIMES (Dec. 3)
reports:

     The Bank of Japan should set an explicit
     inflation target of 3 percent to beat deflation,
     two senior officials of the Finance Ministry
     wrote in a joint article in the Financial Times
     on Monday.

     "The BOJ would have to adopt innovative,
     nontraditional antideflationary policies," said
     Haruhiko Kuroda, vice minister, and Masahiro
     Kawai, deputy vice minister, for international
     affairs at the ministry.

     "These should include an explicit inflation
     target of 3 percent to be achieved in stages --
     such as 1 percent inflation within a year, and 2
     percent to 3 percent within the following two
     years," they said.

     Toward this end, the BOJ should buy long-term
     government bonds and other financial instruments
     to provide more liquidity to the market and
     constantly increase base money, the article said.

http://www.japantimes.co.jp/cgi-bin/getarticle.pl5?nb20021203a5.htm

This announcement comes in the middle of one of the most stupendous periods
of peacetime monetary expansion in history for any modern industrial
nation.  Click through and look at the charts for Japan's Adjusted Monetary
Base, which has fallen from about 33% per annum to a "mere" 21%.
The M-1 money supply has risen in this period from under 5% per annum in
late 2000 to over 30% in the most recent report.

This has drastically reduced interest rates: the supply of money is
increasing in the face of borrowers' resistance to take on more debt. 
Government bonds return a little over 1%, and the 3-month CD rate is barely
above zero percent.

What must be bothering the Ministry of Finance is the M-2 growth rate.  It
is a little over 3%, up from less than 2% in 2000.  The M-2 aggregate
includes the public's savings deposits in banks.

http://research.stlouisfed.org/publications/iet/japan/page2.pdf

The Japanese public is exchanging bank accounts for currency.  Currency
pays no interest, but it is safe from a bank default.  In fact, widespread
bank defaults would produce a premium price for currency.  "A bird in
hand is worth two under the bush."  The lower that bank account
interest rates go -- now barely above zero -- the less expensive it is for
depositors to switch from a savings account to currency.

Prices are falling slightly in Japan.  The huge discrepancy between M-2 and
M-1 growth indicates that there is a quiet run on the banks: the exchange
of savings accounts for currency.  Cash is emperor in Japan.  In a nation
filled with people who don't use credit cards and who prefer currency,
there is a lot of slack in between the Adjusted Monetary Base and M-2.  So,
conclude the two
officials,

     "Aggressive monetary reflation is needed most in
     Japan," they said, adding that it would help
     prevent the accelerated pace of bank and
     corporate restructuring from imposing further
     deflationary pressure on the economy.

     Kuroda and Kawai also proposed that a "concerted
     global reflation" policy be pursued by the
     central banks of the United States, Europe and
     Japan to minimize the risk of a delay in economic
     recovery and price deflation globally.

     "A tripartite strategy for global reflation would
     bring major benefits to the world economy with
     minimum cost," they said, adding that China
     should also be involved because it, too, is
     undergoing price deflation despite high growth
     performance.

I love that last phrase, "undergoing price deflation despite high
growth performance."  This makes high economic output sound like a
negative factor.  It is if the public is sitting around, hoping and praying
for (say) higher computer prices.  "Save us from discounts!" 
Keynesians do not admit that falling prices, when they are the result of
rising output, move the world away from scarcity in the direction of
greater wealth for all.

Japan's problem is not falling prices through rising output.  Rather, its
problem is falling prices due to a contracting economy, i.e., a shrinking
division of labor. The central bank-funded boom economy has turned into a
bust.

(Ad snipped...)

RE-LIQUEFYING THE BANKS

At the end of November, a new era began in Japanese central banking.  To
the extent that "the Japan disease" spreads to other Western
countries, so will the proposed cure spread.  The proposed cure is the
monetization of equity.  THE JAPAN TIMES (Nov. 30) reported this.

     The Bank of Japan began buying shares held by
     banks Friday, taking on increased risk in a bid
     to help banks unwind cross-held shareholdings
     with borrowers.

     Mitsui Trust Holdings Ltd. and a group of
     unidentified banks asked the BOJ to purchase
     several billion yen worth of stock by the end of
     the day, the central bank said.

     The purchases are part of the BOJ's plan to buy
     up 2 trillion yen worth of commercial banks'
     shareholdings by September 2004.

     Banks hold large amounts of stock issued by their
     biggest corporate clients, a legacy of Japan Inc.
     With cross-shareholding, banks shielded companies
     from irate stockholders and corporate takeovers
     and allowed them to carry through with long-term
     projects.

     Those stock holdings have slumped and are one of
     the major threats to bank capital, resulting in
     over 2 trillion yen in unrealized portfolio
     losses in stocks and bonds at the end of
     September.

The two-trillion yen figure is not so great a number as it appears.  Two
trillion yen are worth less than $20 billion.  Therefore, I regard this as
a token purchase. What does this token accomplish?  It sends a message to
the
investing public in Japan and also the world of central banking.  This
message is simple: "There's more where that came from."  If the
BoJ thinks that commercial banks are in danger because of falling capital
ratios due to falling
share prices, it will intervene to solve the problem.

This policy means that the Basle Accord is a dead letter.  It has always
been a dead letter, as all such accords are in a world without a world
government.  A central bank can increase the domestic money supply at any
time, and thereby inflate the domestic economy, even in the face of
"tight" international capital requirements for commercial banks. 
Central banks can relieve pressure on their countries' commercial banks by
monetizing bank equity.  

Corporate shares are easy to monetize.  There is a market for them, even
the high-risk, low-profit stocks on the JASDAQ, the equivalent of the
NASDAQ.  Have no fear; the Bank of Japan is here!

     The government requires banks to reduce the
     balance of their shareholdings to a point equal
     to or lower than their core equity capital by the
     end of September 2004. The BOJ has offered to buy
     up shares exceeding this amount.

     All of Japan's major banks have signed up for the
     stock purchase program, with the exception of
     Sumitomo Trust & Banking Co., which has already
     met the government's shareholdings requirements.

     But what about the quality of the portfolio of the
     Bank of Japan?  The article continued:

     The day before the purchases, BOJ stocks on the
     Jasdaq over-the-counter market fell to a 16-year
     low, reflecting concerns over how the purchases
     might damage the quality of the central bank's
     assets.

http://www.japantimes.co.jp/cgi-bin/getarticle.pl5?nb20021130a2.htm
     
But what does it matter what the quality of assets is? If the central bank
is not only the lender of last resort, but also the buyer of last resort,
then all assets have a potential market.  If the central bank is buying any
category of assets, then existing holders of these assets can cash out of
their investments at any time.  The point is, the quality of any asset is
measured by its liquidity, and if the central bank is a buyer of last
resort, then everything deserves a AAA rating by Moody's -- everything
except the yen.  This leads me to North's law of junk investing:

     "When you can sell junk assets to the central
     bank for cash, then cash becomes junk."

CONCLUSION

In the ongoing debate between the those predicting price inflation and
those predicting price deflation, the theoretical issue of the monetization
of equity should not be avoided.  This is because monetary theory has
turned into monetary policy in Japan.

There are real inflationists out there: policy-makers who recommend
monetary inflation in order to produce price inflation.  There is not one
visible policy-maker on earth who recommends price deflation as a way to
re-structure
capital values in terms of the new, post-inflation economy. The entire
world is a bubble economy, yet there is not one public official with any
influence who calls for central banks to stabilize money, refrain from
interfering in the
money markets and debt markets, and allow commercial banks to sink or swim
in terms of free market competition.  To recommend such a policy of
non-interference is to recommend the transfer of economic authority away
from the central bank to the investing public, including bank depositors.
The central bank, beginning with the Bank of England in 1694, was invented
in order to thwart the economic authority of the individual
investor-depositor.

(RJT:  And the statists couldn't have _that_,  could they?  :-)

The monetization of debt is the central bankers' pay-off to the national
politicians who chartered the private central bank as a quasi-government
agency.  If necessary, there will be additional pay-offs to any organized
financial group that has sufficient political clout to be a threat to
central bank's monopoly over money.

A central bank is designed to achieve two primary goals: (1) provide loans
to the government; (2) to protect commercial banks from depositors who
might become part of bank runs.

There is a third goal, which was tacked onto central banks during the Great
Depression: to provide sufficient credit money to persuade consumers to
keep spending, thereby keeping the economy growing.  This is the area of
agreement among all schools of economic opinion except the Austrian.

This is why a central bank will not find resistance when it adopts the
policy of monetizing equity.  Owners of assets want to bring buyers with
money to the national auction when the buyers decide to sell.  There is
nothing like a central bank's digital printing press to assure sellers that
buyers will have money to bid at the auction.

There isn't going to be long-term price deflation until after the mass
inflationary crack-up boom has taken place, i.e., the collapse of bank
money's value.  This boom era will be the junk money stage.  Until it ends,
would-be
buyers of goods and services will get access to money.  If they refuse to
borrow, therefore refusing to spend, then there will be a buyer of last
resort: the central bank.

The reverse Midas touch will continue: turning junk assets into junk money.

(Snip...)

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