Two weeks ago, Japan once again surprised market participants. After multiple conversations discussing options for further easing, Bank of Japan Governor Haruhiko Kuroda took no action in changing policy. In January, Kuroda surprised the markets by adopting Japan’s first negative interest policy. Japan joined Denmark, Sweden, Switzerland, and the European Central Bank in charging banks for deposits. In other words, commercial banks now have to pay for holding money in excess of regulatory minimums. (For more on negative interest rate policy, click here to view Steve and Amber’s recent video.)
For Japan, this is only one step in a long line of government initiatives to stimulate the economy. Since the 1990s economic growth has been anemic, with GDP growth averaging under 1%, and the adoption of a zero interest rate policy in 1999 did little to improve things.
In addition to negative rates, the Bank of Japan has been buying Japanese debt—to the tune of $67 billion a month. This compares to the Fed’s purchases of $80 billion a month; however, the US economy is about three and a half times larger. Today, Japan’s debt relative to its economy is by far the highest in the world. Its debt-to-GDP ratio stands at 229%. This compares to the US’s ratio of 104% and to Greece’s of 177%. Yes, even Greece has a much lower debt ratio.
The reason Japan is buying debt is to push interest rates lower, which should cause investors to move into riskier assets—just as the Fed did here—but with a budget deficit of over 50%, the Bank of Japan has to buy $300 billion in government debt just to cover the budget deficit, meaning a good portion of the buying has little impact. In addition to debt purchases, the Bank of Japan is spending about $27 billion a year buying Japanese equities via ETFs.
Unfortunately, these purchases, as well as moving to a negative interest rate policy, will probably have the same effect on the economy as moving to a zero interest rate policy had. Lowering interest rates to negative levels will not spur additional borrowing if the economy looks precarious. Additionally, adding debt to a debt riddled nation will not address the problem of Japan’s growth.
The problem with Japan’s growth stems mainly from an aging population and a smaller workforce, not a lack of capital. Japan’s working population is shrinking and is projected to shrink by about 750,000 a year until 2060. Accepting immigration could help solve this problem, but given a long-standing cultural aversion to inflows of foreigners, and one of the world’s most rigid immigration policies, this solution seems to have little chance.
The rise in corporate earnings versus its stagnant GDP growth highlights the problem. Japanese earnings have grown over 500% in the last twenty years, which compares favorably to corporate growth during that period here in the US. To achieve this growth, Japanese companies have grown abroad where labor is more abundant. Japan Inc. has grown profits from its global operations while its domestic economy has languished.
While increasing debt may not stimulate its economy, luckily for Japan it does not face the same challenges Greece faces with its debt. Greece has to rely on foreign investors to buy its debt. Hence, when these investors lost confidence, interest rates rose and Greece was essentially shut out of the credit markets. Japan, however, buys most of its own debt. The Bank of Japan has been (by far) the largest buyer and will continue to be. So the Japanese government needs debt to cover its huge budget deficit, and the Bank of Japan buys this debt, and this cycle will continue. I wish I could say this is a virtuous cycle, but I fear this experiment will not end well. Coming to grips with the deficit may be the more prudent route.
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