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November 4, 2013

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“there can be no wall of money flowing out of Japan without a wall of money flowing into Japan.” The idea is that the current account and the financial account have to balance, so without a larger c/a surplus (= money coming into Japan) there can’t be a larger f/a deficit (= money flowing out of Japan). But there are actually three major accounts: the current account, the financial account, and MOVEMENT ON RESERVES. The fact that central banks sometimes have to enter the market to balance supply and demand for a currency shows that the c/a and f/a don’t always balance naturally, or at least not at prevailing FX rates. For example China — admittedly an odd example with its capital account restrictions — has a surplus on both the c/a and f/a, which is why the PBOC has to intervene so much (or perhaps it has this dual surplus because the PBOC intervenes so much). In the case of Japan, the institutions selling JGBs, REITs etc. to the BoJ suddenly find themselves with excess reserves and a diminished portfolio of interest-bearing assets. They could decide to reinvest those reserves in foreign assets above and beyond the current account surplus, no? The excess supply of yen/demand for dollars would either be made up by the BoJ absorbing the flow through intervention or by the yen depreciating until f/a outflows do equal the c/a inflows. I would argue that encouraging such outflows is one of the unstated purposes of Japan’s QQE.

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