When the only outcome of an emergency meeting between Bank of Japan (BoJ) governor Masaaki Shirakawa and prime minister Naoto Kan yesterday (August 30) was a ¥10 trillion (US$119 billion) additional tranche to a cheap credit facility and a ¥900 billion of pre-budgeted fiscal stimulus, economists across the market jeered.
They called the additional funds wholly insufficient to help reinvigorate the country’s economic growth or to help combat the appreciation pressure on the Japanese yen.
As J.P. Morgan Japan economist Masaaki Kanno told asiamoney.com, “at the moment the overnight call rate is 10 basis points (bp) while the two- year JGB [Japanese Government Bond] yield is 13bp, so it’s almost flat between the two.
“So even if the central bank extends the facility from three to six months the impact is almost negligible. The message is that the BoJ has overextended policies and has little room left for conventional policies.”
Kanno, and many of his peers, believe that the central bank and government have to adopt more radical solutions to begin solving Japan’s problems, especially if the export-reliant nation is to drop its appreciating currency valuation.
The yen has increased in value from ¥92.56 against the US dollar on January 1 to ¥84.82 today (August 31). Such a rise makes Japanese exports less competitive against rivals, which threatens to exacerbate the country’s moribund economy.
Richard Jerram, the Japan economist for Macquarie Securities, is a longstanding critic of Japan’s political and economic direction. When asked his opinions on what the government and central bank should do to invigorate the country’s economy, he snorts that this would be a “fantasy discussion”, but goes on to offer a few ideas.
“I think it would be much more constructive if a deliberate cooperation between the government and the Bank of Japan,” he said. “People would criticise this as a diminution of the BoJ’s independence, and they would be right, but this would be a good thing as any increase in inflation expectations is going to need to involve a regime shift at the central bank.”
Both Jerram and other economists note in essence that the prospect of deflation in the country’s economy is easy enough to solve: print money.
“The most effective thing to do [to reverse deflation] is to helicopter a money drop into the economy,” said Jerram. They could offer a cash gift to the public that is funded by increase of cash into system. The only thing that is unclear is the scale needed but that doesn’t matter as for the sake of argument you could send ¥10 trillion through the post next week and have BoJ permanently print money to finance this. And if that was not enough you could do it again. In the end you would hit the right amount.”
The advantage of this would be that it also depreciates the value of the yen, as Japan’s money supply increases.
But printing money has a problem. If the central bank attempts it but the market does not believe the government will maintain its fiscal discipline at the same time the yields of JGBs could rise. That would make it harder to service the country’s whopping debt burden, which amounts to around 200% of GDP.
An Alice in Wonderland world
J.P. Morgan’s Kanno offers an alternative solution: introducing negative interest rates. It’s a fascinating plan in concept, but one that lacks any real life examples.
“Negative interest rates would probably benefit the government as it could lower bond yields, which would no longer have to face a zero rate boundary," he said. "An overnight call rate and short-term money rate that is below zero would offer some advantages but at same time some costs, and whether the BoJ should introduce such a step depends on whether the former outweighs the latter.”
Negative interest rates seem to be somewhat counterintuitive, or “entering Alice in Wonderland territory,” as Kanno describes them. Theoretically a negative rate would mean depositors pay to keep their money at banks and banks pay people to accept money that they lend.
In reality this it would be unlikely to work that way. Kanno says that instead the central bank would need to bring its IOER rate, or the interest on excess reserves rate, to below zero. This rate is the amount that the central bank pays banks that hold their reserves with it. Reversing the rate would instead charge them for holding reserves, encouraging the banks to lend this money instead.
In that event banks may opt instead to hold paper currency instead, so the central bank would need to also charge them for all bank notes held to forestall such activity. The result would hopefully be that the banks are incentivised either lend or invest their money, most likely in JGBs, bringing down yields.
However there are disadvantages, such as harming bank profits and encouraging households to merely hold bank notes. But Kanno believes that the worst scenario is that the BoJ puts its interest rate policy floor at zero.
“It kills the market," he said. "Market participants believe that it’s a zero rate boundary, so it means the market rate will not move further and therefore no incentive anyone to participate in market and it disappears.”
Introducing negative rates would circumvent such certainties and force banks to start lending more, while dropping long term interest rates too.
Jerram notes that such ideas are clever, but he believes that the central bank is most likely far too conservative to ever try something so radical, and that lower interest rates under zero would also be harder to implement than merely adding cash to the economy.
The BoJ or the government could also invest heavily into onshore and offshore instruments, in particular into US Treasuries. The act of converting yen in US dollars to buy such instruments would be a counterweight to the appreciating pressures on the yen, hopefully limiting or reversing its appreciation.
J.P. Morgan’s Kanno notes that the government could create such a fund and hold an equity portion in it, while encouraging private investors to put money into it too. The appeal would be that the government then takes any initial losses that the US Treasuries make. And he notes that if the government doesn’t want to be seen directly intervening in the yen’s value it could instead use proxies as its investors, such as the Export-Import Bank of Japan.
“This would help the Fed drop US Treasury yields and the Bank of Japan could play a role providing liquidity for private investors that invest in the fund. A lot of options are possible once you leave conventional policies behind.”
CLSA’s Kato has similar ideas, noting that heavy intervention into the US Treasury market to offset appreciation pressures looks like an increasingly likely alternative for the central bank at the very least.
Alternatively the BoJ could start heavily buying longer tenor JGBs to drop their yields, and making it cheaper to borrow long-term money. To do so effectively however it would need to drop its restriction of not buying more JGBs than bank notes that are circulated.
Another option would be for the Bank of Japan to begin to heavily intervene in the foreign exchange market – something it could once again do by printing money to finance it.
A number of observers already believe that this is almost inevitable, given the continued rise of the Japanese yen’s value. However Susumu Kato, chief economist for Japan at CLSA is less certain.
He believes that the BoJ wants the reassurance of a coordinated intervention in line with other nations. In other words, it wants the excuse of following the US Federal Reserve instead of taking the initiative.
He feels that the central bank should be more proactive. “Japan should intervene in the FX market and inject more funds into the market,” he said. “It’s the simplest way of stopping the yen’s appreciation.”
Kato believes that without such intervention the yen could appreciate further, increasing in value towards Y80 to the US dollar. “If it goes that far the market might then expect ¥70 so I think the Japanese government should intervene earlier, perhaps before the currency breaks through ¥83,” he said.
The trouble is that without the backing of a coordinated move, such intervention does not look likely. Plus currency intervention that is not on a massive scale will yield only limited success, especially if the US economy weakens, causing the US dollar to drop in value further and Treasury bond yields to fall.
In fact all three of the economists Asiamoney.com spoke to were to varying degrees gloomy about the likelihood of the BoJ thinking outside the box when it came to the country’s economic problems.
“It partly stems from memories of times when inflation was an issue,” said Jerram. “Plus there’s a question of accountability. A game for the past year is that the government has pushed the BoJ to push this [inflation-creating policies], in large part so the politicians have plausible deniability in the future [in case it fails]. And the BoJ does not want to play that game and says that if it is to do radical movements the politicians need to fully back it.”
But for all the cynicism of any meaningful policy evolution, J.P. Morgan’s Kanno still holds out some hope.
“The BoJ has been quite innovative in the past; it introduced the zero rate policy and quantitative easing, and it purchased assets like stocks. And the Bank of England followed the latter action in late 2000; despite the fact that nobody had thought other central banks would conduct such measures at the time.
“So if the BoJ were to do anything new this time around it’s possible that other central banks would follow once again.”