The strong Japanese yen is puzzling investors and policy makers alike. The currency has gained 12.8% in value since Dec. 1, hitting 17-month highs in recent days, as the stock market has fallen. That’s despite the Bank of Japan 8301 0.27 % ’s Jan. 29 announcement of negative interest rates on some reserves.
It’s usually unwise to read much into market fluctuations, but other data suggest this is no fluke. Recent surveys show that Japan’s companies and its consumers are losing confidence in the economy and they expect already minuscule inflation to fall.
Deflationary expectations can become a self-fulfilling prophecy, as the expected real return on yen-denominated assets rises, even if the nominal return remains minimal. That in turn encourages more savings, creating a vicious cycle. In other words, Japan is still stuck in a deflation trap, and Prime Minister Shinzo Abe’s reliance on monetary policy to get out of it hasn’t worked.
The BOJ’s negative interest rate experiment also shows how attempts to manipulate expectations can backfire. In principle, a lower return on savings should spur companies to invest, consumers to spend and investors to seek higher returns abroad. For a few days afterward, the stock market rallied and the yen weakened in expectation that this would be the case. But then a backlash took hold.
Bank stocks took an immediate hit, as it became clear their profits will be hurt by the negative rates. Companies and households simply don’t want to borrow, so banks have no choice but to accumulate more reserves and pay the penalty. They are already vulnerable as the profit margin on lending is minimal, so if they seek out riskier investments it could lead to losses.
Investors quickly realized that although the Bank of Japan said it could further push rates into negative territory, it has limited scope to do so without destabilizing the financial system. Bank of Japan Policy Board Member Sayuri Shirai also recently confirmed that the BOJ will run out of bonds to buy in the middle of 2018, so more quantitative easing is also not an option. BOJ Governor Haruhiko Kuroda has fired his last bazooka.
Japanese households were also unsettled by negative interest rates. Eight days before the announcement, Mr. Kuroda testified in the Diet that he was not considering the unorthodox policy. He may have wanted to use the element of surprise to maximize the effect on the markets, but to ordinary Japanese the sudden reversal looked panicky.
Japanese have responded by hoarding more cash at home, which protects them against negative rates and bank failures. Sales of safes have rocketed, and the Finance Ministry announced that it will print 17% more of the highest-denomination banknote this year. One economist estimates that cash stored at home grew by $46 billion over the past year to a total of $367 billion.
More than three years after Prime Minister Abe promised to conquer deflation, Japan is back where it started, but deeper in debt. Former IMF Chief Economist Olivier Blanchard recently warned that, with an aging population, at some point Japan’s government will have to attract foreign bond buyers with higher yields.
2--Japan’s Negative-Rate Experiment Is Floundering--Trading withers in money markets, yen goes on a tear; ‘every day is like being Alice in Wonderland’
“Interest-rate levels are having little effect on credit demand, the market function is declining. You can’t expect everything to go according to plan.” ...
There is no guarantee that lowering interest rates encourages corporate capital expenditures or expedites the shift of household financial assets from savings to investment,” said Nobuyuki Hirano, president of Mitsubishi UFJ FinancialGroupInc., Japan’s biggest bank, on Thursday, adding the negative-interest policy had caused households and businesses to rein in spending amid growing uncertainty over the future. ....
If the money market dries up, if there is an event like the Lehman crisis, there won’t be the infrastructure for banks to raise capital,” said Naomi Muguruma, strategist at Mitsubishi UFJ Morgan Stanley Securities. “It could cause interest rates to rise sharply.” ...
“There’s no rhyme or reason on why the yen would strengthen when interest rates are negative,” said Bart Wakabayashi, managing director at State Street Global Markets. STT -0.85 % “But the yen has now reasserted itself as a safe-haven currency on concerns about China and the global economy. And at the same time, doubts are emerging over the staying power of Abenomics.”
3--What Comes After Negative Rates? Helicopter Money --For central banks, fantasy monetary policy would mean handing out money directly to the population
Mathematicians moved on from negative numbers to imaginary numbers. For central banks, fantasy monetary policy would mean handing out money directly to the population in what economists have long called a “helicopter drop.” If the negative rates experiment fails, this might move from the realm of fiction to fact.
4--Hitler vs. Bernanke (archive)
Here’s a little background from C.K.Liu’s Asia Times article “Nazism and the German Economic Miracle”:
“The Nazis came to power in Germany in 1933, at a time when its economy was in total collapse, with ruinous war-reparation obligations and zero prospects for foreign investment or credit. Yet through an independent monetary policy of sovereign credit and a full-employment public-works program, the Third Reich was able to turn a bankrupt Germany, stripped of overseas colonies it could exploit, into the strongest economy in Europe within four years, even before armament spending began.” (“Nazism and the German Economic Miracle,” Henry C. K. Liu, Asia Times)