Economists trying to divine where the Federal Reserve is headed are poring over through reams of data, charts and policy speeches. They really should be looking at Tokyo.
Japan has provided many a cautionary tale over the last decade – deflation, dismal demographics, corporate scandals, the dangers of nuclear reactors. One of the most important, though, is the incredible staying power of zero interest rates. In 1999, the Bank of Japan stepped into the free-money matrix in which it’s been trapped ever since. Though the BOJ pulled off a couple of modest hikes in 2006 and 2007, it quickly rebounded to the quantitative-easing experiment pioneered by former Governor Masaru Hayami.
Let that be a cautionary tale for Jerome Powell, who is grabbing the baton from Fed Chair Janet Yellen.
Sure, the Fed has bragging rights versus the BOJ. Since December 2015, it has managed to put 125 basis points of distance between America’s benchmark rate and zero. In that time, Japan’s bank pushed long-term rates negative, cornered the government bond market and bought up 75% of the country’s exchange-traded-fund market.
The Fed, though, may soon bump up against a wall similar to the one that’s blocked Japan for 19 years: collective monetary addiction.
Central bankers are supposed to take away the proverbial punchbowl just as the party is getting going. Since the 2008 “Lehman shock,” as the Japanese call it, monetary policymakers have become bartenders, serving up monetary cocktails to bankers, companies, investors and governments. Predictably, everyone got hooked.
When the mixologists at the BOJ tried yelling “last call” in July 2006 – hiking rates from zero to 0.25% – markets groused. In early 2007, it yanked away the punchbowl anew. The result: open revolt in markets. Credit spreads stumbled. Inebriated asset classes grew volatile. Corporate earnings staggered. Rising government debt levels caused headaches for Tokyo bureaucrats.
The Fed knows Trump would blame it early and often for killing the bull market
Similar withdrawal symptoms will challenge the Powell Fed. Not the least of his worries is Donald Trump, a president as drunk with power as any in modern US history. Between his bully pulpit and his @realdonaldtrump Twitter feed, the Fed will be in the line of fire if rising bond yields slam the stock market. Just as China’s Communist Party sees 6.5%-plus growth as vital to its legitimacy, the White House views a surging Dow Jones Industrial Average as the ultimate trump card. Wall Street’s boom, Trump’s team argues, absolves all manner of sins and scandals.
The Fed knows Trump would blame it early and often for killing the bull market. That’s not to say the Fed won’t pull off another rate hike this year. As David P. Goldman argued in a February 1 Asia Times piece, all indications point to “modest increases, rather than sudden jumps.” But if Japan is any guide, make that very modest.
During his BOJ tenure (1998-2003), Hayami was hounded by government officials, corporate chieftains and investors to ease more. So was his successor, Toshihiko Fukui (2003-2008). When Fukui hiked rates, the full weight of Japan Inc. pounced, demanding he refill the punchbowl. Even after the next governor, Masaaki Shirakawa (2008-2013), returned rates to zero, banks, exporters and politicians clamored for more. Today’s BOJ chief, Haruhiko Kuroda, faces a fresh backlash over a surging yen. Bottom line, central banks that go to zero get stuck there, or thereabouts.
One could argue that the Fed should be trying to take some air out of a DJIA up 32% in the last year alone. Or at the very least, mopping up liquidity to fuel future gains. The Fed has been here before, though. In late 1996, then-Fed Chairman Alan Greenspan got dragged before Congress for a tongue-lashing after his infamous “irrational exuberance” warning. In an odd bit of serendipity, Greenspan wasn’t referring to dot-com froth but Japan’s Nikkei. Still, he avoided talking about stocks again after that.
Two-plus decades later, Japan is once again offering clues not just about where Fed policy might be heading, but also why its options are running dry. Drink, anyone?