Image: Euro © Royalty-Free, Corbis

Friday's market action on the very weak U.S. jobs number -- just 88,000 jobs created in March -- put worries about U.S. economic growth on center stage.

At least in the short term.

With earnings season highlighting companies' growth for the first quarter and projected growth for the second quarter, and with the Commerce Department set to release retail sales figures for March on April 12, I think it will be easy for the market to get caught up in growth worries and for the bulk of investors to start behaving as if growth were the most important issue facing the market.

Don't go with the crowd. Recent numbers casting doubt on U.S. growth rates shouldn't be ignored, but they haven't changed the basic forces driving global financial markets.

This is still the central banks' game. And currencies -- the relative price of the dollar, the euro and the yen -- are still the most important mechanisms for transmitting messages from the central banks to the markets.

And if I'm right and this remains the central banks' game, I'm looking for a strengthening dollar (and a weakening yen and euro) to continue to put downward pressure on the price of oil, copper and other commodities -- and to continue the rout in gold.

U.S. economic growth does figure into this equation, since weaker- than-expected U.S. growth will temper the boost that the dollar might otherwise deliver to Japanese and U.S. equities. Decent growth in the U.S. economy is likely to give the current rally more room to run.

But growth is really a sidebar to the main story.

Japan's huge effort

That's not to say that the story hasn't changed at all. Now it won't be just the huge flood of cash from the central banks that sets the terms of market behavior, as it has for the last two years. Now the timing of individual central bank policies counts for as much as the net direction of those policies when it comes to determining the moves of individual global financial markets.

image: Jim Jubak

Jim Jubak

Right now, the most important market "fact" is the increasing difference in timing between the U.S. Federal Reserve, on the one hand, and the Bank of Japan and the European Central Bank on the other.

The Fed has started to talk about cutting back on its monetary stimulus this year and maybe even ending its monthly purchases of $85 billion a month in Treasurys ($45 billion) and mortgage-backed assets ($40 billion) by the end of 2013.

The Fed is still a long way from actually raising interest rates -- Chairman Ben Bernanke and company have pledged not to raise rates until unemployment falls to 6.5% or less, and that looks like 2014 at the earliest. But with rates already effectively at 0%, the Federal Reserve isn't going to be cutting rates, either.

Contrast that with the Bank of Japan, which just last week announced it would double its current stimulus effort and buy $80 billion a month in bonds. That brings the Bank of Japan's program of bond buying into rough equivalence with the Fed's $85 billion a month -- until you take account of the much smaller size of the Japanese economy. Japan's $80 billion in bond buying, if you correct for that size difference, is equal to $279 billion a month in the U.S. economy. The effort will expand the Bank of Japan's balance sheet by roughly 1% of gross domestic product a month. In contrast, the Fed's massive program of bond buying expands the U.S. central bank's balance sheet by 0.54% of GDP a month.

We're talking a huge effort. And that's exactly what you'd expect from a central bank that is trying what may be Japan's last chance to blast itself out of a long-term deflationary trend that, combined with the country's rapidly aging population, would result in a steady decline of standard of living in Japan.

Will it work in the long run? I hope so, but I have doubts. Severe doubts.

Deflation hurts Japan

Masaaki Shirakawa, who was replaced as governor of the Bank of Japan by Haruhiko Kuroda last month, has defended the central bank's efforts to battle deflation, arguing that much of Japan's deflation was structural. Globalization has produced lower prices for Japanese consumers and companies -- a process dubbed the "Wal-Mart effect" for its power to lower U.S. inflation. And Japan's deflation has gone on for so long that it is now engrained in the minds of Japanese consumers and companies -- everyone expects prices (and demand, if you're a corporate manager) to be lower tomorrow than today. And that influences buying decisions.

In the short run, the Bank of Japan's aggressive new policy will produce a cheaper yen, which will make Japanese goods more competitive in global markets.

Japanese companies will get a second boost to revenue and profits from the weak yen as revenue is translated back from strong dollars, yuan and other currencies. I think that will lead to the yen falling to 102, or 105 or even 110 to the dollar.

And I think that will continue the current rally in Japanese stocks. Many estimates of earnings for the first and second quarters of calendar 2013 are based on company estimates of 90 yen or so to the dollar. The yen was at 98 to the dollar in early trading today.

In the slightly longer but still short run -- let's say 6 months or so -- this policy threatens serious potential problems.

First, if the yen sinks fast enough and far enough it will lose its status as a global safe-haven currency. Currently, when some crisis threatens, in say, the eurozone, money flows in to the yen. It's a deep and liquid market, and the cost of borrowing yen is very low. But if the yen comes to be seen as a falling knife, forget about the currency as a safe haven and forget about the bounce the yen gets whenever there is a crisis. That means the yen will have fewer bounces to slow its decline.

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Second, if the speed of that decline increases enough or the dimensions of the decline get large enough, some of Japan's huge pool of domestic savings will start to move overseas. Buying a U.S. Treasury bond would only get more attractive to Japanese retail investors.

That development would be extremely important, because it's the willingness of domestic Japanese savers to buy Japanese government bonds, despite almost invisible yields, that has enabled Japan to support the world's highest debt burden as a percentage of GDP.

If some of that money starts flowing overseas in search of better yields and more stable currency, then Japan's ability to self-fund its debt becomes an issue. Once doubts about self-funding start to rise, the momentum can easily get out of hand, as credit-rating companies and institutional investors jump on the bandwagon.

Total effect: A weaker yen and a stronger dollar.

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