Japan found itself the odd economy out at last weekend’s Group of 20 meeting, where monetary normalization was the rage.
The first synchronized global recovery in over a decade has central banks winding down post-Lehman Brothers emergency stimulus. That is, except for a Bank of Japan going the other way.
Much of the chatter in Washington was about how much the Federal Reserve might tighten this year. And which major authority might follow its lead most closely – the European Central Bank, Bank of England or Bank of Canada?
That puts BOJ Governor Haruhiko Kuroda and Japanese Finance Minister Taro Aso in an awkward spot, explaining why the No. 3 economy is stuck at zero. Yet their common explanations miss the point. Sure, inflation is barely halfway to the BOJ’s 2% target and wages are stagnant. The yen would skyrocket, tanking exports, if the BOJ withdrew stimulus.
The real problem is the bond market.
The rise in 10-year US yields to 3% this week has traders harkening back to James Carville’s remark in 1993. As the advisor to former president Bill Clinton quipped: “I want to come back as the bond market. You can intimidate everyone.” The idea being that when you troll the bond vigilantes, investors who take matters into their own hands, all hell breaks loose.
Herein lies Tokyo’s Catch 22 and it’s a lesson to economies large and small.
When you hoard nearly half of the government bond market and 75% of exchange-traded funds, you tend to get trapped. Just as bad, you tend to deaden not just market dynamics but the very animal spirits you’re trying to enliven.
The first problem can be seen in a strangely placid debt market. On certain days, like March 13, not a single debt instrument changed hands. Considering Japan’s $9 trillion-plus bond arena is the second-biggest, that is not normal – or okay. From December to February, Tokyo issued some $68 billion of 10-year debt. The BOJ holds more than 70% of them.
It’s ironic, really. The BOJ flooded the globe with yen to help reanimate Japan’s zombie industries and companies. In doing so, it zombified not just markets, but the entire economy.
That gets at the other challenge, one crystallized at the G-20 confab. Could it be that by keeping rates too low for too long, the BOJ is getting the opposite response from the real economy it hoped for? One possibility: keeping the economy on life support since 2001 is sapping confidence.
The US presents quite a contrast. America’s journey to zero and back lasted seven years. Japan, it’s 17 years and counting. In fact, the talk now is of Kuroda & Co. going even further into the monetary unknown. It won’t do any good, of course. Taking quantitative-easing to new levels won’t get Japan Inc. to fatten paychecks, consumers to spend or executives to take risks.
It will, though, maintain some homeostasis in a bond market intimidating Tokyo. Call it mutually-assured financial destruction. Government bonds are the main financial asset held by, well, everyone: banks of all size; companies; endowments; insurance companies; local governments; pensions; the postal system; universities; and, of course, the fast-growing ranks of retirees.
Thanks in part to the BOJ’s epic exposure, more than 90% of Japanese government bonds are held domestically. That limits the risk of capital flight. But it also traps the BOJ in a debt market that could stumble spectacularly if it throttled back. The fallout from fewer BOJ purchases could exceed anything Carville might’ve imagined 25 years ago. Japan’s 10-year bond currently yields 0.05%. A surge to 3%, where the US is now, would be too devastating to contemplate.
It also explains why for many G-20 meetings to come, the BOJ will find itself in a very lonely monetary place.