Japan last week announced a radical plan to finally slay the deflation dragon that has stalked their economy for the last 25 years. The sheer magnitude of the BOJ’s program should put to rest once and for all whether monetary policy can truly work as the growth tonic that policy wonks such as Ben Bernanke fervently hope. The BOJ will double the monetary base over the next year, essentially buying assets at a clip equivalent to a bit over 1% of Japanese GDP – every month. If it doesn’t work it won’t be from a lack of trying. They will concentrate primarily on long term JGBs, buying 30% more than the net new supply over the next year which should also put to rest the question of whether central banks are truly monetizing government debt. The answer from the BOJ is a resounding yes and I’d suggest they be prepared to buy them all just in case. Mrs. Watanabe – the mythical Japanese retail investor – is looking abroad for anything not denominated in Yen at this point. It is a curious theory that posits that economic growth is dependent on driving capital from your home market but there it is and the action in Japanese stocks and the Yen indicates that the theory does not lack for adherents.

We are long an ETF right now – and have been since last summer – that is long Japanese stocks and hedged against the Yen exposure. When the Yen falls and Japanese stocks rise, we win in two ways and it has worked like a charm since we initiated the position. Our investment was based on nothing more than a realization that the Japanese government was out of options except to devalue the Yen and attempt to inflate their way out of their debt problems. As the Yen devalues it should raise the nominal value of Japanese assets such as stocks. What it won’t do – at least anytime soon – is to change the output of the Japanese economy. While existing output may show up as a higher volume of Yen, it probably won’t change the volume of actual, you know, stuff coming out of Japanese factories. I’ve said for some time that Japan’s problem is a nominal one and one of perception at that. What I’m not sure of is whether the rising cost of imported inputs – oil for instance – will offset whatever rise Japanese corporations might see in Yen revenue. If China continues to slow, cutting global demand for commodities, the Japanese corporate sector may be able to show a significant rise in Yen earnings as revenues rise faster than costs which in turn should be good for the Nikkei. As for actually raising real output from Japanese factories, that would likely take a more significant devaluation of the Yen and many years to happen. Production can’t just be shifted about on a whim based on the recent volatility of the currency market.

What I’m trying to say and not saying it very well is that the Japanese blitzkrieg of money creation will do what all such central bank emanations do – raise inflation. If the Japanese are lucky – and I think they might be – the inflation will show up in asset prices more than consumer prices but make no mistake, it is inflation when the value of your currency falls. Most people tend to look at the value of the currency as it relates to a basket of consumer goods but if we’ve learned nothing over the last 20 years it surely should be that concentrating solely on the price changes of an arbitrary basket of consumer goods to direct monetary policy is a big, big mistake. With the Fed working on its third asset bubble in 15 years, all while consumer prices have been fairly well behaved, it is stunning to me that monetary policy is still seen as the savior of the economy rather than the fairly obvious source of our problems it is. I guess myths die hard and ones that have the patina of academic approval die hardest.

Back here in the US, the Fed’s own monetarist experiment has done nothing to get the US economy back on track except raise the price of owning a piece of corporate America. With interest rates pegged at zero and people inexplicably wanting at least a nominal return on their assets, dividend stocks have become the latest object of investors’ affections. We have benefitted from the trend since we’ve owned some of these stocks for a long time but have recently decided that the risk of loss, should something happen to lessen investors’ ardor for all things dividend related, vastly outweighs the potential rewards at these prices. There are exceptions but generally I don’t find much in the way of interesting, high quality stocks anymore. We are generally value investors and use fundamental screens to identify stocks we might want to buy. When I ran my screens in 2009, I would have to adjust the criteria to reduce the size of the list from thousands to something manageable. When I ran the screens a year ago, I would get hundreds of stocks as a starting point. Now, I get tens of stocks to choose from.

So the Fed’s serial quantitative easings have had an impact on the price of equities but the effect on the real economy is harder to discern except in how it has rearranged the chairs on the deck of the titanic US economy. The rise in oil prices has produced a boom in North Dakota that likely won’t survive prices under about $60/barrel if and when that condition occurs, which with a large chunk of the global economy either in recession or on that path, might be sooner than anyone currently expects. The fall in interest rates has prodded the housing market out of its burst bubble induced slumber as hedge funds and other “investors” have rushed in to capture rental yields that have now fallen to mid to low single digits. So Fed policy has had an impact on the economy but whether it is desirable or sustainable is open to question.

Meanwhile, the average household’s income is still falling and savings rates are not far above where they were before the housing bubble burst, which means that real recovery continues to be delayed.  The immediate cause of the flaccid state of the US economy continues to be a lack of job creation. Based on the most recent employment report the US economy is being solely supported by people earning a paycheck cooking meals at Applebee’s and spending it eating at McDonald’s. That might also explain Target’s recent politically incorrect decision to label some women’s fashions as being available in Manatee Gray. You can read Jeff Snider’s take on the full employment report here, but suffice it to say that we were not impressed. I’ll admit that, like a few others, I don’t think the employment report was an outright disaster but it was equally far from confidence building.

The jobs report and the other weaker than expected data last week didn’t seem to have that much of an effect on stocks, with the S&P 500 down a mere 1%. After the initial thrust downward Friday, stocks spent most of the rest of the day edging back to the upside I guess on the theory that weak data just delays the day when the market will have to face the inevitable end of the Fed’s largesse. Or maybe it was on the idea that Mrs. Watanabe is eyeing 3% dividend yields and a rising US Dollar like a dog eyes a T-bone. One does have to wonder when or if Ben Bernanke will admit defeat in his quixotic quest to create economic growth with nothing but a printing press at his disposal. There appear to be no modern day Sancho Panza’s on the FOMC.

Stocks are also ignoring the message of the bond market, the long end of which has managed to quietly rally a neat 6%+ just since early March. A rally of that magnitude and a flattening yield curve are not generally associated with the sort of growth that produces big gains in earnings. The bulls will of course point to Europe as the culprit with savers there spooked by the confiscation in Cyprus. There may be some truth to that but it would be hard to find in the daily movements of the Euro/Dollar exchange rate which rallied smartly after the ECB’s monthly refusal to cut rates. Stock bulls will also point to the Fed’s buying in the Treasury market as a reason to ignore prices there but with most of their buying in the 10 year and less range, I’m inclined to take a rally in the 30 year bond to mean what it has always meant – weaker growth. Our portfolios continue to reflect that expectation rather than blind faith in the ability of the Fed to levitate an overvalued market.

It hasn’t worked in Europe and it hasn’t worked in the US but maybe Japan is a special case and the BOJ’s money printing will be the domino that tips the world into a virtuous circle of growth. We better hope so because there doesn’t seem to be a plan B. We’re all monetarists now.