The extraordinarily bold economic experiment in Japan

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Japan to keep printing money for years to come, so learn to enjoy it

Ambrose Evans-Pritchard. The Telegraph

The Bank of Japan will have to mop up the entire issuance of public debt for years to come, covering the budget deficit with printed money

There are no one-way bets in global finance, but Japan's stock market comes close. The authorities are about to funnel large sums into Japanese stocks openly and deliberately under the next phase of Abenomics, both by regulatory fiat and by purchasing the Nikkei index directly with printed money.

Prime minister Shinzo Abe is unshackling the world's biggest stash of savings, the $1.3 trillion Government Pension Investment Fund (GPIF). Officials say the ceiling on equity holdings will rise from 12pc to around 20pc as soon as August, opening the way for a $100bn buying blitz.

Fund managers are suddenly in a race to get there first. Japan Post Bank - where Mrs Watanabe dutifully places the family money, confiscated from her Salaryman each month before he can spend it - is itching to rotate more of its $2 trillion holdings into equities before inflation pummels the bond market. So is Japan Post Insurance, no minnow either at $850bn.

Mr Abe's move comes sooner than expected and amounts to a market shock, though nobody should be shocked anymore as he keeps doubling down on the world's most radical economic experiment.

The Nikkei index stalled in December after rising almost 100pc since September 2012, even though the Bank of Japan (BoJ) is still showering the economy with money, buying $75bn of bonds each month. The BoJ's balance sheet will reach 70pc of GDP by March 2015, three times the US Federal Reserve's.

The index is down 7pc this year to 15,000, chiefly because foreigners have taken profits and pulled out $140bn, causing some to write off Abenomics as a flop. Japan's trust banks are picking up the baton. They added a record $2.5bn last week, some of it on behalf of the GPIF itself as it adapts to the new order. "We think the Nikkei will get to 18,000 by October," said Genzo Kimura, from SuMi Trust Fund.

The Bank of Japan is helping it along, buying exchange traded funds based on the Nikkei and Topix indices. "They purchase whenever the market falls, usually by about $200m each time," he said.

The bank is well on its way to defeating deflation under Haruhiko Kuroda, the first governor to launch QE with enough force to break the vicious circle. It is not yet a done deal. Three board members remain sceptical, and one (Takahide Kiuchi) thinks the undertaking is doomed to failure.

Yet core inflation has turned positive for the first time since 1997. The consumer price index rose to 1.4pc in April, adjusted for taxes. Real interest rates have plunged through the floor, transforming Japan's debt dynamics and the role of money in the economy.

Real borrowing costs on 10-year government bonds are no longer among the highest in the industrial world. They have fallen to -0.8pc. By this mathematical magic, public debt is levelling off near 245pc of GDP, after rising from 216pc in 2010. Japan has, for now, averted a compound interest trap.

Nobody disputes that the debt ratio is dangerously high. One government after another pursued a fatal mix of tight money and ultra-loose fiscal policy, the infamous bridges to nowhere. Each spree fizzled out without achieving escape velocity.

Chronic budget deficits ensued, yet nominal GDP still contracted by 8.5pc between 1997 and 2013, with hideous effects on the debt trajectory. Such is the power of monetary contraction. Mr Abe is at least trying to overturn this whole deformed structure.

Negative rates are forcing money out of the mattresses. "Companies have been holding on to $2 trillion because they had no incentive to spend, but cash is no longer king. Toyota is investing $5bn in a new Prius plant," said Mr Kimura.

The economy did not buckle when consumption tax was raised from 5pc to 8pc in April, as widely feared. There has been no repeat of the disastrous tax rise in 1997, which kicked in at the outset of the Asian financial crisis. This time fiscal shock absorbers were in place to cushion the blow. Machinery orders are surging back to pre-Lehman highs.

"Although there will be some inevitable contraction in the current quarter as a payback for the elevated rush of demand before the tax increase, we believe that the underlying growth momentum remains strong," said David Lipton, from the International Monetary Fund. "You can see that in the tight labour market conditions, high capacity utilisation and strong investment in the first quarter. We project growth will be 1.4pc this year."

Japan's "misery index" has risen to its highest since 1981 as Japanese workers feel the pain of rising food and import costs from yen devaluation, without seeing the gains. Yet the one-off hit is largely over. Unemployment has dropped to modern-era lows of 3.6pc. That is likely to halt the fall in real wages very soon, if it has not done so already. Pay rises in the Spring round of talks were 2.14pc, with a bonus of 0.48pc to be paid in June. Restaurant wages in Tokyo are up 10pc in a year.

Ryutaro Kono, from BNP Paribas, says the country is on the cusp of an acute labour shortage as the demographic crisis deepens. The number of young males aged 15 to 34 has collapsed by a quarter from 10.47m to 7.88m since 2000. "Young workers come from a steadily shrinking supply. It will be increasingly hard for firms to find cheap labour," he said.

Mr Abe must now deliver the "Third Arrow" of his national revival plan, a Thatcherite blitz intended to drag Japan's pre-modern service sector into the 21st century, break the feudal grip of the rice farmers, reverse the falling birth rate with three-child families and make the workforce a place fit for women.

None of this will be easy. Nor is it clear that he can smash Japan's edifice vested interests - allegedly by using the Pacific trade deal as a sledgehammer - since those interests are largely owned by the Liberal Democrat Party. The IMF warns that unless Mr Abe steps up the pace when he unveils new measures this month, trend growth will remain stuck below 1pc, too little to lower the debt ratio.

Even if Mr Abe's reflation strategy succeeds, he will have to face the terrifying consequences. Who will buy his bonds once inflation takes off and devastates creditors? "Rising interest rates could trigger fiscal and financial chaos owing to the enormity of Japan's public debt," said Mr Kono.

"The Bank of Japan will have to hold rates down even after deflation ends, and this will be the start of full-fledged financial repression. Unless Japan is very lucky, the merits of ending deflation will be dwarfed by the demerits of a destabilised economy."

The BoJ will have to mop up the entire issuance of public debt for years to come, covering the budget deficit with printed money. Officials admit privately that this is the purpose. Mr Kuroda will not stop when the 2pc inflation target is reached. There will another long phase when the BoJ says it must be sure. "There is room for interpretation," said one insider.

Mr Abe has never disguised his aim, telling a Mansion House audience in London that his policies were inspired by Takahashi Korekiyo, who lifted Japan out of deflation in the early 1930s by reducing the central bank to an arm of the Treasury. "His example has emboldened me. It is impossible to get rid of ingrained deflationary psychology unless you clear it out all at once," he said.

The US Treasury and the Federal Reserve played the same dirty pool in the late 1940s, whittling away war-time debt by stoking inflation while keeping debt-holders captive by repression. Such a policy amounts to a haircut for creditors, often the elderly. It is harsh. Yet Japan is picking the lesser of poisons. The pre-Abe paralysis was leading ineluctably to bankruptcy.

Pessimists ask what happens five years hence when the Bank of Japan has accumulated half the government's debt stock, with a balance sheet beyond 100pc of GDP, technically insolvent itself.

Optimists answer that nothing will happen. The BoJ's liabilities are an electronic accounting fiction. The debt can be switched into zero-coupon bonds in perpetuity, or the certificates can be burned on a ritual pire beneath the cherry blossoms. Japan will have slashed its debt to manageable levels by legerdemain. Too good believe? We will find out.

[ArtM72]

Smart and informed optimists at the end of the day will have transitioned to ....?.....in their holdings.

[admin]

It's an extraordinary experiment, especially because the had let the problem fester for the good part of two decades, the public deficits and the deflation together got the public debt spiraling out of control, which makes the situation potentially rather dangerous.

If interest rates on bonds seriously start to rise (something people like Kyle Bass are betting on for quite some time already), that will be a big problem, and indeed the BoJ might have to buy up all the issued debt for quite some time.

What not that many people realize though, Japan should have listened to Milton Friedman at the end of the 1990s. Here is what he said:

[T]he Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?” It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

Macro and Other Market Musings: Abenomics as a Fulfillment of Milton Friedman's Policy Prescriptions

And, as the article already mentioned (Evans-Pritchard is a monetarist, like Friedman), it has been successfully tried in the Japan of the 1930s.

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It's not only Friedman, it's Reagan too:

Japan's government is planning to cut the country's corporate tax rate -- a move that could prove as controversial as the recent consumption tax hike. According to media reports, Japan's ruling Liberal Democratic Party has cleared the way for a corporate tax cut in 2015 and Reuters reported on Thursday that the rate may be lowered to below 30 percent within a few years to help revive growth.

Japan plans corporate tax cut, but does it need it?

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This time around, Abe didn't ignore the economy. Backed by economic adviser Koichi Hamada and Bank of Japan Governor Haruhiko Kuroda, Abe first implemented the biggest monetarist push in world history. He went the opposite direction of Europe, and -- unlike the U.S. -- he gave every indication that the shift toward monetarism was permanent. The result: Japan has escaped deflation. The stock market is up, growth is way up and even wages are finally starting to rise.

Japan's Abe Is the World's Best Leader - Bloomberg View

Indeed, if you compare what they're doing in Japan to the muddle through in the eurozone, one could argue that the eurozone is the new Japan..

That's what they've been doing for two decades and there isn't much reason to think the outcome in the eurozone will be different.

[admin]

Olivier Blanchard, former chief economist at the International Monetary Fund, said zero interest rates have disguised the underlying danger posed by Japan’s public debt, likely to reach 250pc of GDP this year and spiralling upwards on an unsustainable trajectory... The BoJ is soaking up the entire budget deficit under Govenror Haruhiko Kuroda as  he pursues quantitative easing a l’outrance. The central bank owned 34.5pc of the Japanese government bond market as of February, and this is expected to reach 50pc by 2017... Japanese officials admit privately that a key purpose of ‘Abenomics’ is to soak up the debt and avert a funding crisis as the big pension funds and life insurers retreat from the market. The other unstated goal is to raise nominal GDP growth to 5pc in order to ‘bend down’ the trajectory of the debt ratio, a task easier said than done.

Olivier Blanchard eyes ugly 'end game' for Japan on debt spiral

The story seems plausible to many, and thus is deeply challenging for the backers of sound money principles. The financial TV commentators tell us that the yen is now the safest of all the safe havens. How can this be so?

Japan's monetary experiment just beginning - Business Insider

It is not easy to decisively break out of a growth slump associated with the bursting of a financial bubble. The longer an economy is stuck in a low-growth regime, the greater the structural headwinds impeding an economic liftoff. This affects not just the current growth trajectory, but future potential, too.

5 Lessons From Japan's Negative Rates: Mohamed A. El-Erian

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Of course, they also think those negative rates are a bit of a con as Japanese “authorities are attempting to push bond yields down below existing nominal GDP, so that the existing debt can be converted or ‘consolidated’ into a perpetual zero coupon bond presumably before any ‘tapering announcement’.”

Jefferies: Japan has a fever and the only prescription is NGDP targeting and zero coupon perpetual bonds | FT Alphaville

We’ve written about all of this before, including Jefferies’ prediction that this will end in a place of NGDP targeting and zero coupon perpetual bonds — a place which will either seem inevitable or barmy in ten years time. However, it’s worth noting that they are doubling down ahead of the April 27 BoJ meeting as the yen refuses to listen to Kuroda and his negative rates — since the BoJ announcement of negative rates, the yen has appreciated around 10 per cent on a trade-weighted basis say Jefferies.

Jefferies: Japan has a fever and the only prescription is NGDP targeting and zero coupon perpetual bonds | FT Alphaville

Of course not all Japanese debt is long-term, nor is it all newly issued, but the point is that the market value of its outstanding debt would drop sharply if interest rates rose to even modest levels. If the 30-year rate got as high as 7.0 percent (lower than the U.S. rate in much of the 1990s), then the market price of the newly issued 30-year bond would drop by more than 85 percent from its current level. The way governments typically keep their books, this plunge in the market price would not affect Japan’s debt to GDP ratio. But if the markets were actually troubled by the high ratio of debt to GDP, Japan could simply issue new debt to buy up old debt at a fraction of its face value. This would quickly send its debt to GDP ratio plunging. (This is why the Reinhart-Rogoff 90 percent cliff story never should have passed the laugh test even before the exposure of the famous Excel spreadsheet error.)

Olivier Blanchard Is Worried About Inflation In Japan | Beat the Press | Blogs | Publications | The Center for Economic and Policy Research

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The Bank of Japan (BoJ) made a "fateful miscalculation" when it opted to hold interest rates at its meeting last week, Goldman Sachs has said. The BoJ maintained its -0.1 percent deposit rate and its 80 trillion yen ($0.8 trillion) base money target on Thursday, surprising market watchers who had forecast further stimulus measures.

Bank of Japan made ‘fateful’ error last week, says Goldman Sachs

King’s starting point is that the 2008 crisis wasn’t an anomaly but the natural consequence of bad incentives that are still baked into money and banking -- and so quite likely to create another, possibly even greater, crisis.

The Book That Will Save Banking From Itself - Bloomberg View

You’ll have noticed that the yen and Nikkei were displeased yesterday. Like throw your toys out of the pram because you didn’t get what you wanted displeased. Like one of the worst one day JPY moves in the past decade displeased. What they didn’t get, and what prompted that tantrum, was any auld bit of easing from the Bank of Japan. And here are eight potential reasons why the BoJ disappointed, from SocGen:

Explaining the BoJ’s reticence | FT Alphaville

All of Japan's jawboning on the yen - and expectations the Bank of Japan (BOJ) will need to further ease policy - are unlikely to weaken the currency for long, JPMorgan Private Bank's Asia forex boss told CNBC. Ben Sy, head of fixed income, foreign exchange and commodities for Asia at JPMorgan Private Bank, said Japanese companies and investors still had substantial offshore assets.

BOJ can't weaken yen despite NIRP while domestic buyers bolster the currency, says JPMorgan Private Bank

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With its broad range of world-beating industries, Japan should have no trouble at all to sell - and outsell - anybody on world markets. Asia, in particular, should be Japan's most important export playground. That area is the fastest-growing segment of the world economy, it represents one-third of the global output and takes 53.3 percent of Japan's total overseas sales. Unfortunately, Japanese exports to Asia and the rest of the world are not doing well. They plummeted at an annual rate of 8.4 percent in the first four months of this year. Over the same period, exports to Asia fell a whopping 11.5 percent, marking a continuation of Japan's weakening export trend to its Asian neighbors observed during 2015. It is intriguing that all that is happening to Japanese exports in (Asian) economies where GDPs are advancing at annual rates between 3 percent and 7.3 percent.

Japan could be a world-beating exporter but went for easy BOJ money instead

Tokyo, we have a problem. Last week, market tumult stemming from the U.K.'s vote to quit the European Union drove the British pound to its weakest levels in three decades. Yet it also sent investors flocking to traditional safe haven assets like the U.S. dollar, gold and the yen, the latter surging against every major currency as the results of Brexit became clear: Dollar/yen spiked from a Thursday high near 107 to a two-year low near 99. Meanwhile, the pound lost more than 8 percent against the yen and the euro shed more than four percent to hit a three-and-a-half-year low.

Brexit fears send yen soaring, complicate Japan’s efforts to manage policy

The International Monetary Fund’s fiscal department estimates that Japan did a consolidation of over 2 percentage points in 2014 and another half point or so of fiscal consolidation in 2015, net of any gains from lower interest payments.* Japan has a history of passing lots of highly hyped stimulus packages. But in many cases those stimulus packages just offset the roll-off of past stimulus packages, without generating much net fiscal impulse to the economy. Postponing the consumption tax hike consequently makes a great deal of sense. Japan’s economy—the domestic side at least—never recovered from the last hike.

Follow the Money » Japan’s First Consumption Tax Hike Was a Demand Disaster

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Article 5 of the Public Finance Act prohibits directly underwriting newly issued JGBs other than "in exceptional circumstances," and also requires any such exception to be authorized by the Diet, the Japanese Legislature. But a new Credit Suisse research note reports that the central bank does, in fact, underwrite JGBs upon maturity. This is a process known as "BOJ rollover," because when government bonds owned by the Bank of Japan are retired, the proceeds can be used to underwrite government bills for the purpose of rolling over the government's debt. Credit Suisse also calls the process a "stealth weapon" because the operation has already been preapproved by the Diet — a sort of permanent exception.

The Bank of Japan has a 'stealth weapon' at its disposal - Business Insider

Prime Minister Shinzo Abe's promise of a hefty fiscal stimulus package, revealed by Japanese media on Wednesday, has effectively forced the Bank of Japan to come up with matching monetary ammunition at the close of its two-day meeting on Friday.

Shinzo Abe's fiscal stimulus talk puts onus on Bank of Japan to ease

While economists crib about delayed structural reforms and incomplete fiscal consolidation, stock owners would give Prime Minister Shinzo Abe’s economic revitalization plan more than a passing grade. When it comes to return on equity, 143 companies in the Nikkei 225 index are in better shape now than they were four years ago, whereas only 72 have seen their fortunes dwindle. Breaking down return on equity into its constituents, it's clear much of the improvement is a product of healthier profit margins. Companies have succeeded in turning a weaker yen into a competitive advantage, which is why the fear of the exchange-rate tailwind turning into a headwind is demoralizing investors.

Decoding Abenomics - Bloomberg Gadfly

Disdain for Abenomics is also forgetful, failing to recall the grimness of late 2012, when deflation seemed inescapable, the yen was export-sappingly strong and the Nikkei 225 stockmarket index, now above 16,000, languished below 10,000 (it peaked at nearly 39,000 in 1989). Compared with past efforts to revive Japan, Abenomics has achieved a great deal. It has defeated core deflation (excluding energy prices); lifted companies’ profits and dividends; expanded employment, especially among women and the old; and sprinkled Japan with a light dusting of gentle reforms that may hold the promise of more radical future ones. In early 2013, for instance, few believed that Japan would sign the Trans-Pacific Partnership, an ambitious free-trade agreement among 12 countries: it did (though the TPP’s fate now rests on American politics). Against the will of the country’s powerful business lobby Mr Abe introduced a corporate-governance code and guidelines to oblige shareholders to be more active.

Three-piece dream suit | The Economist