Japans’s Scary Lesson on Slashing Interest Rates
Christine Lagarde wants her staff at the International Monetary Fund to examine what might happen to the global economy when central banks begin to raise interest rates. She’s wasting their time.
If Japan has taught us anything, it’s that slashing rates to zero and beyond is a lot easier than returning them to normalcy. Japan is on its sixth central-bank governor since its bubble burst in 1990, and like his predecessors, Haruhiko Kuroda is doubling down on quantitative easing. Why? Politicians, bankers, investors and businesspeople alike get addicted to free money all too easily and clamor for more.
Once central banks start embracing assets such as corporate debt, commercial paper, mortgage-backed securities, exchange- traded funds, real-estate trusts and the like, monetary officials tend to get stuck. That’s especially so in nations carrying large, and growing, debt burdens.
“They simply can’t afford any meaningful increase in interest rates,” says Simon Grose-Hodge, head of investment strategy for South Asia at LGT Group in Singapore. “The Japan experience suggests very low rates are going to be around for a long time.”
What Lagarde should ask her staff to do is study how the nature of economics and capitalism will be altered by most Group of Seven nations maintaining zero-rate policies for another decade or more. The “liquidity trap” that deadens the benefits of monetary easing is morphing into a “stimulus trap,” which is much harder to shake.
Japan’s two lost decades are worth considering. The nation of 127 million people has been living with zero rates for so long that they seem, well, normal. Under the surface, credit spreads mean little, not when the underlying assets on which they are based are drugged up on monetary stimulants. Bank balance sheets get muddied. So do the government’s books, as it becomes hard to discern where a central bank’s holdings begin and end. Corporate shenanigans are easier to disguise.
Oddly, free money has done more to hold Japan back than to revive it. Monetary largesse relieves the pressure on politicians to make industries, from electronics to steel, more competitive and innovative. It concentrates capital in nonproductive sectors such as construction, telecommunications and power, and it starves others -- like startup companies -- that could fuel job growth.
Zero rates also sapped the urgency from Japan Inc. at the very worst moment, just as it needed to keep up with a cast of growth stars in Asia, China included. Even when Japan has churned out growth of, say, 3 percent, it has been more artificial than organic. All that liquidity was meant to support so-called zombie companies and industries that employ millions. It has led to a “zombification” of the broader economy, complicating Prime Minister Shinzo Abe’s revival efforts.
Ultralow rates, for example, have exacerbated Japan’s fiscal woes because the costs of adding to the world’s largest public debt appear negligible. Someday, bond traders will decide that a debt more than twice the size of a $5.9 trillion economy is too great for a rapidly aging population. For now, 10-year yields of 0.58 percent warp politicians’ sense of long-term risks.
China looks certain to fall into this stimulus trap, too. The yen’s 20 percent drop in the past six months, at a time when the Chinese economy’s prospects are already looking gloomy, has infuriated officials in Beijing. Cutting rates will do little good, as China grapples with its longest streak of sub-8 percent growth rates in at least 20 years. That could mean a yuan devaluation.
Lagarde isn’t alone in her optimism. New York University economist Nouriel Roubini, known as Dr. Doom, said April 24 that the Federal Reserve will end its zero-rates policy in two years. Goldman Sachs Group Inc. Chief Economist Jan Hatzius says rates will start to rise after January 2016.
Yet imagine the congressional inquisition that would greet the Fed’s first move to sell the assets it has loaded up on since 2008, never mind to raise the federal funds rate. Think about the bellyaching and lobbying on Wall Street about which holdings the Fed should dump. That would signal that a trade in excess of $3 trillion is about to roil markets. Take the Fed’s portfolio of mortgage-backed securities. In an economy as housing-centric as America’s, selling those off could devastate a sector closely tied to consumer confidence.
Similarly, Lagarde should be able to picture the outrage that would follow any step by the European Central Bank to withdraw from euro-zone debt markets. Lawmakers would quake. Investors would panic anew. Businesses, used to years of eating at the public trough, might curtail investment and hiring plans. The ECB should expect angry calls from China, which has been stocking up on euro-denominated bonds.
Since governments have shown an inability to take bold steps to remake their economies, central bankers have stepped in to fill the void. The trouble is, many are already reaching the point of no return. To understand what the future really holds, the IMF’s researchers only need to look at Japan.
(William Pesek is a Bloomberg View columnist. The opinions expressed are his own.)
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