Bank of Japan Governor Haruhiko Kuroda warned today that with the further decline in oil prices, Japan may well re-enter deflation.

Kuroda’s words signal a remarkable failure of one of primary pillars of the world’s most aggressive national QE policy to foster domestic inflation and consumption. However, the BOJ is succeeding at devaluing the yen via other means, namely through record borrowing to buy US assets.

As Bloomberg reports: “Financial institutions borrowed 10.2 trillion yen ($84 billion) to send to headquarters overseas in November last year, the most since the same month in 2008, BOJ data show. ”

Simultaneously Japanese banks, crowded out of the domestic JGB market are soon to overtake China as the largest creditor to the United States. Bloomberg added: “Japan has since built a stake of $1.2386 trillion, Treasury Department data released showed, pulling within $1 billion of China as America’s largest foreign creditor.”

The gap between Japan and Chinese Treasury purchases are both due to increasing Japanese purchases as they seek to eke out greater returns than domestically available and the Chinese reducing their purchases. Driving flows is performance. With a shortage of high quality yield-generating assets, Treasuries purchased by Yen borrowing were the best performing rate carry trade over the last 6-months, returning over 17% and expected to return more than 5% more by year end.

Japanese purchases of U.S. Treasuries will soon overtake China’s and provide an insight as to the Fed’s overall insouciance regarding the strengthening dollar as the markets price the beginning of rate increases in this year regardless of decidedly mixed economic data. In the era of zero interest-rate policy in Japan and now NEG-IRP in Europe, the U.S. is the only asset market with both depth and yield to absorb the growth in yen and euro borrowing. Not only in Treasuries but also in equity and real estate – primary asset classes where international zero interest rate borrowings will end up and support the U.S. financial system and valuations.

It is the stated or implicit goal of QE in both Japan and Europe to devalue their currencies. The U.S. Fed is happy to help as the one way currency trade creates unprecedented demand for U.S. assets and caps long term interest rates, largely with cheap internationally borrowed money.

Funding U.S. Treasury and global risk asset purchases with zero rate borrowing in weakening currencies, of course, tends to blow up spectacularly in volatile risk-off environments as in 2008/9, as funding currencies are repatriated on risk asset unwinds and surge leading to further unwinds – a classic deleveraging “death spiral”. The larger the cross-currency funding asset/funding mismatch, the greater the incentive global central bankers, attached like Siamese twins with different agendas but one somatic life source have to maintain a “risk on” environment to perpetuate the concurrent goals of currency devaluation and high valuation asset support in a zero growth, deflationary world.

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