Investors who predict the European Central Bank will start buying government bonds this week to fight deflation shouldn’t expect too much if Japan is any guide.
The Bank of Japan’s experience is a real-life example of the Keynesian economic theory of a liquidity trap, in which money printed by a central bank is hoarded in anticipation of further deflation rather than invested. Japan’s 10-year yield dropped to a record 0.225 percent last week and similar maturity inflation-linked debt signals consumer price increases of 0.74 percent, failing to meet the BOJ’s 2 percent target.
Japan and Europe are expanding quantitative easing at a time when the Federal Reserve is winding up its program, causing turbulence in the financial markets. The yen has plunged almost 30 percent against the dollar in the past two years, making Japan’s government debt the world’s worst performers in U.S. currency terms. The euro slumped 12 percent in 2014 amid concern ECB President Mario Draghi’s easing will be as ineffective as that of BOJ Gov. Haruhiko Kuroda.
“We are in a liquidity trap,” Yusuke Ito, a senior fund manager for Mizuho Asset Management in Tokyo, said in a telephone interview last week. “They’re expecting too much. Even if you provide lots of liquidity to the market, banks do not increase the liquidity to their customers. We are pretty much doubtful about the effect of QE.”
Mizuho Asset, with the equivalent of $34.3 billion in assets, holds European bonds in shorter maturities than those in the benchmark it uses to gauge performance, reflecting its position that the rally isn’t justified, he said.
Kuroda reiterated last week that he plans to keep easing monetary policy until he reaches his inflation target.
John Maynard Keynes, who lived from 1883 to 1946 and was the founder of Keynesian economic theory, warned that there comes a point when yields are so low that almost everyone prefers holding cash to debt, robbing the central bank of its control over interest rates. He argued in favor of fiscal stimulus in times of economic distress.
Paul Krugman, the Nobel-prize winning economist, said in an October opinion piece in the New York Times that Japanese fiscal policy “didn’t do enough to help growth.” The West has fallen into a prolonged slump similar to Japan’s, Krugman wrote.
Prime Minister Shinzo Abe delayed the completion of a two-stage sales tax hike after executing the first stage in April. The world’s third-largest economy fell back into recession in the third quarter of last year.
Japan pioneered quantitative easing in 2001, buying government bonds and pumping money into banks in the hope that they will increase lending. Kuroda, who took over as the head of the central bank in 2013, last increased JGB purchases in October to as much as ¥12 trillion a month, a record.
Five-year yields dropped to zero last week, encouraging money managers to invest in companies. The Topix share index has risen 16 percent in the past three months. The decline in the yen has made Japan’s exports cheaper for overseas buyers. Japan’s currency had dropped 11 percent over the past 12 months to 117.04 per dollar as of 10:33 a.m. in Tokyo.
Yet the performance of the economy is mixed. Consumer price inflation, excluding fresh food and the effects of April’s sales tax hike, rose 0.7 percent in November, less than half the BOJ’s target. Industrial production and retail sales both slid in November.
Bank lending climbed 2.8 percent in November, the fastest increase since 2009. It was still short of the 4.1 percent peak set in 2008. Japan is planning a record budget for the next fiscal year, which starts April 1.
Japanese debt handed investors a 23 percent loss in 2013 and 2014 in U.S. dollar terms. It was the worst performance of 26 bond markets tracked by Bloomberg and the European Federation of Financial Analysts Societies.
Draghi this month said policymakers are making “technical preparations” to boost prices, raising speculation he is planning to follow Kuroda’s model. ECB policymakers will meet on Jan. 22.
“Kuroda is trying to raise inflation expectations, but it’s very difficult to say he’s successful,” Naruki Nakamura, the head of fixed income in Tokyo at BNP Paribas Investment Partners Japan, said by phone last week. BNP Paribas Investment Partners manages or advises on the equivalent of $597.8 billion worldwide. “It’s not like magic. It will not change the whole picture immediately with the end of disinflation or the return of growth.”