Japan’s Bold Move of Nothing

Stop the presses! Japan will make a bold attempt to stop falling prices. Making the yen worthless at a 2%-per-year clip is the promised land, according to the new Bank of Japan (BOJ) governor Haruhiko Kuroda.

“This is monetary easing in an entirely new dimension,” Mr. Kuroda said following the bank’s decision. The Nikkei 225 finished 2.2% higher for the day, at 12,634, on Kuroda’s big idea.

The big idea — the “entirely new dimension” — is for the BOJ to “aggressively buy longer-term bonds and double its holdings of government bonds in two years.” In other words, double the amount of money in circulation.

Whoa, now that’s some secret sauce. How come nobody thought that up before?

Hiroko Tabuchi, writing for The New York Times, calls this strategy a “dramatic turn in Japanese monetary policy.” Up until now, the BOJ has engaged in only a “halfhearted battle to end deflation — the damaging fall in prices, profits and wages that has weighed on its economic growth.”

Halfhearted? Not hardly. Back in 1989, the Nikkei hit an all-time high of 38,916. The average stock was trading at a price-earnings ratio of 80. The capitalized value of the Tokyo Stock Exchange was over 40% of the entire world’s combined stock market value. Japanese real estate accounted for half the value of all land on Earth.

When that doozy of a bubble popped, the supposedly halfhearted BOJ transformed the world’s healthiest OECD country in 1990 into a country with a public debt of 240% of GDP. Bill Bonner quips, “The Japanese tried to cure an alcoholic with heroin. Now they’re addicted to it.”

Japan’s monetary policy aggressively lowered rates to 0.5% between 1991-1995 and has operated a zero interest rate policy virtually ever since.

The Japanese government didn’t just leave matters to the monetary authorities. Between 1992-1995, it tried six stimulus plans totaling 65.5 trillion yen and even cut tax rates in 1994. It tried cutting taxes again in 1998, but government spending was never cut.

In 1998, another stimulus package of 16.7 trillion yen was rolled out, nearly half of which was for public works projects. Later in the same year, another stimulus package was announced, totaling 23.9 trillion yen. The very next year, an 18 trillion yen stimulus was tried, and in October 2000, another stimulus of 11 trillion yen was announced.

During the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession.

In spring 2001, the BOJ switched to a policy of quantitative easing — targeting the growth of the money supply, instead of nominal interest rates — in order to engineer a rebound in demand growth.

The BOJ’s quantitative easing and large increase in liquidity stopped the fall in land prices by 2003. Japan’s central bank held interest rates at zero until early 2007, when it boosted its discount rate back to 0.5% in two steps by midyear. But the BOJ quickly reverted back to its zero interest rate policy.

In August 2008, the Japanese government unveiled an 11.5 trillion yen stimulus. The package, which included 1.8 trillion yen in new spending and nearly 10 trillion yen in government loans and credit guarantees, was in response to news that the Japanese economy the previous month suffered its biggest contraction in seven years and inflation had topped 2% for the first time in a decade.

In December 2009, Reuters reported, “The Bank of Japan reinforced its commitment to maintain very low interest rates on Friday and set the scene for a further easing of monetary policy to fight deflation. The bank said that it would not tolerate zero inflation or falling prices.”

In a paper for the International Monetary Fund entitled Bank of Japan’s Monetary Easing Measures: Are They Powerful and Comprehensive?, W. Raphael Lam wrote that the BOJ had “expanded its tool kit through a series of monetary easing measures since early 2009.” The BOJ instituted new asset purchase programs allowing the central bank to purchase corporate bonds, commercial paper, exchange-traded funds (ETFs), and real estate investment trusts (REITs).

According to Lam’s work, the BOJ bought 134.8 trillion yen worth of government and corporate paper between December 2008 and August 2011. Lam described the impact of these purchases as “broad-based and comprehensive,” but it failed to impact “inflation expectations.”

For more than two decades, the Japanese central bank and government have emptied the Keynesian tool chest looking for anything that would slay the deflation dragon. Reading the hysterics of the financial press and Japanese central bankers, one would think prices are plunging. Or that borrowers cannot repay loans and the economy is not just at a standstill, but in a tailspin. Tokyo must be one big soup line.

This graphic does not exactly portray a deflationary death spiral. Consumer prices have gone nowhere, give or take, for the past two decades. What’s so bad about that?

So what about Japan’s GDP?

Japan’s GDP doesn’t look all that desperate either. Except, of course, that GDP is loaded with government “investments” that wouldn’t survive in a competitive market.

The argument about Japan’s government debt has always been that it is internally financed. However, the government’s ability to finance spending is increasingly constrained by a falling Japanese household savings rate. Japanese private savings has declined from 15-25% in the 1980s and 1990s to under 3%.

That is the rub. Trillions of yen in government debt have been created, and the government is unable to inflate any of it away with its mad printing. More money doesn’t not equal more economic growth.

So far, Japan government bond bears have gone broke reading the same tea leaves we are. However, government funding will be become much more difficult with the declining savings rate and aging Japanese starting to cashing in their bonds. Insurance companies and pension funds are also selling their holdings and buying fewer bonds in order to fund the increase in payouts to people eligible for retirement benefits. Institutional investors and retail investors are also increasingly investing in other assets, desperately seeking yield.

For the moment, Japan has a large portfolio of foreign assets of $4 trillion that will provide some breathing room. However, even if net income from foreign assets (interest payments, profits, and dividends) stays constant, Japan’s overall current account may move into deficit as soon as 2015, according to Satyajit Das, writing for EconoMonitor.

These foreign assets will eventually dry up, and Japan will have to go hat in hand to foreign creditors. As it is, Japan spends 25-30% of its tax revenues on interest payments. “At borrowing costs of 2.50-3.50% per annum, two-three times current rates,” Das writes, “Japan’s interest payments will be an unsustainable proportion of tax receipts.”

Additionally, Japanese government bonds clog Japanese bank balance sheets. When rates go up, it will be devastating for these banks. An increase in JGB yields would result in immediate mark-to-market large losses on existing holdings and slice critical bank equity positions.

The new guy at the BOJ may claim that he’s doing new things. But he brings to mind Bill Bonner and Addison Wiggin’s gruesome observation in Financial Reckoning Day Fallout. “It’s a little like a guy who’s getting good at suicide — if he’s so good at it, you’d think he’d be dead already.”

Japan’s new financial emperor still has no clothes.


Doug French

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