Japan’s Extraordinary Experiment

The Bank of Japan is creating money and buying up Japanese Government Debt on an unprecedented scale. Thus far, the BOJ has bought up 40% of all Japanese Government Debt – and that percentage is increasing with every month that passes. This is a truly extraordinary experiment in monetary policy.

So far, the results of this experiment have been overwhelmingly positive:
1. Interest rates have fallen,
2. The economy has strengthened,
3. The stock market has climbed to a 21-year high,
4. The government’s interest expense has been reduced, and
5. Perhaps, most important of all, 40% of Japanese government debt has been effectively cancelled, greatly reducing the risk of a fiscal crisis in the future.

If this policy continues to boost economic growth in Japan, while at the same time effectively reducing Government Debt and the risk of a future fiscal crisis, it means that other countries could also boost their economic growth through a combination of aggressive fiscal and monetary policy as Japan has done.

It would mean that the world is capable of generating much higher levels of economic growth and general prosperity than it currently is.

Therefore, this is an experiment of historic importance – and one that policymakers in the rest of the world can’t afford to ignore.

Meanwhile, there are also important investment implications. Over the next two years, the BOJ seems likely to continue printing aggressively, while the ECB tapers and then ends its QE program and the Fed tightens monetary policy through a radical policy of Quantitative Tightening. All of this suggests the Yen should weaken. That should be good news for Japanese corporate profits and stocks.

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8 comments

    1. Hi Klaus,

      Thanks for the question.

      Japan would welcome some inflation after a quarter of a century of deflationary pressures.

      We will have to wait and see how much the Yen does depreciate. But, I would be surprised if Japan experiences any significant inflation in the foreseeable future.

      Richard

  1. 5. Perhaps, most important of all, 40% of Japanese government debt has been effectively cancelled, greatly reducing the risk of a fiscal crisis in the future.

    If the BOJ were to cancel JGBs it will have to do it against either liabilities (bank deposits owned by Japanese banks) or equity. If JGBs are cancelled against liabilities Japanese banks who own the deposits will collapse. If JGBs are cancelled against equity the BOJ will operate with a huge negative equity position.

    So will the market accept a BOJ which break the rules and destroy confidence in the yen?

    Technically cancellation of JGBs can be done but the market would likely severely punish the yen.

    Lars M Haugen

  2. What about the effect of negative real rates on pensions and other savers? If you cancel the price discovery mechanism expect unintended consequences. A society cannot survive if debtors get a free ride and savers are starving to death.

    Lars M Haugen

    1. Hi Lars,

      The BOJ does not have to do anything differently than it is doing now. It does not have to officially “cancel” the government debt it owns (40% of the total). It can just keep it on its books and continue giving all the interest income from those bonds back to the government. As long as it never sells those bonds, this can continue forever – meaning that 40% of Japanese government debt has been “effectively” cancelled – so far. The more the better, I say.

      Richard

    2. The “savers” moved into the stock market a long time ago.

      They still have jobs and the ability to save because the government spending over the last 27 years prevented the economy from collapsing into a Great Depression. The savers are not starving to death. Have you been to Japan lately? It still looks very rich to me.

      As far as the “unintended consequences”, we will just have to learn to manage them – and to make the most of the unique opportunities that the combination of fiat money and (deflationary) globalization make possible in the 21st Century.

      1. Hi Richard.

        I agree that the BOJ just can carry on. But anyone doing a value adjustment of the BOJ balance sheet will se an insolvent bank. Question is if market forces will live with that situation forever.

        I admire your videos because they are “mathematical” and fact based. I am therefor surprised that you can claim that pension funds (in general) are ok because they are invested in stocks.

        Also, low rates lead to less investment (Knut Wicksell, 1898).

        This is most likely an “everything bubble” and pension funds are supposed to survive for a long time.

        I do not believe that the BOJ has succeeded in cancelling gravity economic forces.

        Regards

        Lars

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