By Eric Peters, CIO of One River Asset Management
“While central banks in the U.S. and Europe are moving toward monetary tightening or rate increases, the Japanese economy is still on the road to recovery,” said the Bank of Japan Governor. “It is most important to support economic recovery by patiently continuing monetary easing,” added Kuroda-san.
The Bank of Japan first cut interest rates to zero 23yrs ago, and ignoring a couple aborted attempts to briefly normalize policy they have remained at zero or lower ever since.
Government debt exploded in that time, with annual deficits and stimulus packages becoming so commonplace they lost their effectiveness. The central bank bought nearly half the 1.4 quadrillion Yen of government debt that mounted, a stunning 260% of GDP. And yet, through it all, core prices in Japan’s economy remain almost identical today as they were when its zero-interest-rate experiment began.
For decades, it seemed everyone lost money trading Japanese bonds, which moved in counter-intuitive ways. They called the inexorable government bond rally the “Widow-Maker.” Traders with the highest IQs tend to have the least-disciplined risk management, so they suffered most profoundly.
In the years preceding the pandemic, economists claimed they definitively understood how and why Japan’s disinflation developed, persisted, and then manifested in other nations. Secular Stagnation.
Perhaps they did actually figure it out. But no sooner had the economists named their magnificent mental model then the world started to change -- which of course is the only durable model in all of economics. There are others that tend to work too. Like when major central banks are tightening, while others are easing, volatility rises until something breaks badly, at which point policy makers panic (for more on this topic, see "The Biggest Story No-One Is Talking About": Why Albert Edwards Expects "Something In The Market Is About To Snap").
Another model that seems to hold is that highly intelligent economists and central bankers generally believe they understand inflation, as if it is a mathematical equation. And even though inflation appears when they least expect it, and fails to manifest when they most anticipate it, they remain remarkably confident in their ability to predict it.
The more you think about money, the less it makes sense. That is why the topic is so alluring for the masochists amongst us, attempting to solve the unsolvable, climb the unclimbable, conquer the unconquerable.
We engineer thought experiments and mental models in the hope of gaining a glimpse of some truth, the scent of something real, a money-making opportunity. Japan provides an enigma to explore. It once had a bubble so big the Emperor’s Palace was worth more than the state of California. Unreal. Impossible. But so it was.
When that bubble burst, real estate and equity prices utterly collapsed. The Yen strengthened for decades. It remains stronger today than back then. Japan’s exporters carried on, managing costs lower, maintaining competitiveness. The government supported the system, running persistent deficits and in each recession announced a special stimulus.
The central bank stimulated too. In 1999 the Bank of Japan reduced rates to zero, unsuccessfully lifted them a couple times, and in 2015 cut them to -0.10% where they remain. The level of government debt expanded in ways that almost everyone agreed would lead to an inflationary collapse. It did not. The Bank of Japan bought bonds, and now owns roughly 130% of GDP worth of government debt, which is half of the 260% outstanding.
It also pledged yield curve control, bidding for an unlimited quantity of 10yr government bonds at a 0.25% yield. Could the central bank create money, buy all the outstanding bonds, and simply burn them? Execute a modern version of an Old Testament debt jubilee? The currency of a nation that chooses this path should weaken, as it is now doing in Japan.
But might it be possible for a country to pull off such a feat without full monetary collapse? We don’t know, yet. What seems certain though, is that if you were to attempt such a bold maneuver, you would absolutely want to be the first nation to try.