It’s limbo, Japanese-style: How low can bond yields go without triggering a meltdown?
This question gains urgency as 10-year government yields disappear before the world’s eyes. At 0.83 percent, the lowest level since 2003, they hardly compensate investors for the risks inherent in buying IOUs from the most indebted nation. Public debt is more than twice the size of the $5.5 trillion economy. Worse, it’s still growing. Fitch Ratings today lowered the sovereign-credit rating by one step to A+ with a negative outlook because of Japan’s “leisurely” efforts to cut debt.
Ignore news that gross domestic product rose an annualized 4.1 percent from the final three months of 2011. The only reason Japan is growing at all is excessive borrowing and zero interest rates. The moment Japan trims its debt, growth plunges, deflation deepens and politicians will demand that the Bank of Japan do more. That’s been Japan’s lot for 20 years now.
Yet what if the BOJ isn’t just setting Japan up for the mother of all crises, but holding the economy back?
It’s financial blasphemy even to ask this question in Tokyo. Here, the dogma is that Governor Masaaki Shirakawa is too stingy and must churn out more yen to support the economy. When virtually every economist agrees on something, I get nervous. Remember when all the experts said the subprime crisis was containable? Or, don’t worry, Europe’s banks are sound, China’s economy is unstoppable, Asia has decoupled from the West, and Brazil, Russia, India and China, the BRICs, will save the world?
If there’s any lesson we should’ve learned in the post-Lehman Brothers world, it’s that conventional wisdom is about as reliable as Greece’s parliament. In Japan’s case, it’s time to explore whether zero rates are squandering the nation’s future.
A bizarre dynamic is dominating Japan’s financial system, one evidenced by two-year debt yields falling to about 0.095 percent. That is below the upper range of the BOJ’s zero-to-0.1 percent target for official borrowing costs. It’s below the 0.1 percent interest rate the BOJ pays banks for excess reserves held at the central bank. Such rates raise serious questions.
The BOJ does reverse auctions where it buys government debt from the market. Last week, it failed to get enough offers from bond dealers. Now think about that: The BOJ prints yen and uses it to buy government debt from banks, which typically hoard the stuff. Last week, banks essentially said: “No, thank you. We’d rather have these dismal interest-bearing securities than your cash, because there’s really nowhere to put that cash anyway.” Banks certainly aren’t lending.
Politicians are pounding the table demanding that the BOJ expand its asset-purchase program. That, of course, isn’t possible. The BOJ can hardly force banks to swap their bonds for cash. So Japan is left with a problem unique to modern finance. Banks like to keep more cash on deposit at the BOJ than they need to in order to earn a 0.1 percent rate of return, which is pretty good by Japan standards. To pay that rate, the BOJ creates new money, which does nothing to help the economy.
This dynamic keeps Japan’s monetary engine in neutral at best, and at times running in reverse. Japan’s central bank is essentially now there to support bond prices. It’s a huge intervention that gets little attention. Headlines roll every time the Ministry of Finance sells yen in currency markets. The BOJ’s debt manipulation barely registers.
Japan has long had a bond bubble on its hands. In recent years, hedge-fund managers such as David Einhorn of Greenlight Capital Inc. and J. Kyle Bass of Hayman Advisors LP shorted Japanese debt. Is the world’s biggest bond bubble about to burst? Not necessarily. Tokyo has proved adept at stabilizing yields in times of trouble. Also, more than 95 percent of bonds are held domestically, eliminating risks of a tremendous capital flight.
Endgame in Sight
Yet we are reaching an endgame of sorts. The longer Japan sticks with the status quo, the bigger and more perilous its bubble gets. Japan has created a kind of singularity in superlow short-term rates that drive longer-term ones to unthinkable levels. This arrangement has the economy walking in place and financial incentives out of whack. It can’t last forever.
The BOJ needs to try a very different tack. That could include buying physical assets such as real estate, home mortgages, airports, sports stadiums, rice farms, dormant nuclear reactors, golf courses, universities, entire villages where populations are aging faster than tax revenue is rising, you name it. In other words, get creative and radical.
Some financial tweaks are in order, too. An obvious one is for the BOJ to drive rates on deposits it holds for financial companies to below zero. Were the steady return that the BOJ offers banks to disappear, bankers might put that liquidity to use and make fresh loans. That also would weaken the yen, boosting exporters.
Bottom line, what the BOJ is doing isn’t working. It’s undermining Japan’s growth today and setting it up to become another Greece in the years ahead.
(William Pesek is a Bloomberg View columnist. The opinions expressed are his own.)
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