Japan Shows There's No Need to Fear the Taper

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Anyone worried that the Federal Reserve is about to rock the world with a series of big interest-rate hikes should pause and recall the experience of Toshihiko Fukui.

Bank of Japan governor from 2003 to 2008, Fukui was the last central banker to attempt a tapering process akin to the one Fed Chairman Ben Bernanke launched this week. In 2005, Fukui began scaling back on massive bond purchases amid signs growth was perking up, and by March 2006 he had scrapped Japan's quantitative-easing program. In July of that year, he raised the benchmark rate above zero for the first time since 2000 and followed that 25 basis-point move with another in February 2007.

Things didn't go well. Japan's deflationary economy quickly worsened anew and short-term rates had soon returned to zero. When Masaaki Shirakawa succeeded Fukui in April 2008, his first act was to resurrect Japan's QE experiment. And, of course, Haruhiko Kuroda has taken things to unprecedented extremes since arriving at BOJ in March.

But Japan's experience shows why markets have less to fear from the Fed than many believe. The lesson from Tokyo is that it's a lot easier to slash rates to zero and beyond than to return them to normal. Japan is now on its sixth central-bank governor since its asset bubble burst in 1990, and BOJ governors are still doubling and tripling down on QE. Janet Yellen is likely to fare no better as she inherits the unenviable task of exiting the Fed's ultralow rate regime.

Why? As Japan demonstrates, entire economies tend to get addicted to free money. Sure, folks complain publicly about irresponsible policies and currency debasement, but bankers, investors and politicians alike become reliant on excessive liquidity -- especially in nations carrying huge debt loads.

Also, once the Fed or even the European Central Bank starts spreading its monetary tentacles into mortgage-backed securities, corporate debt, real-estate trusts, exchange-traded funds and, indirectly, stocks, they get stuck there.

Can you imagine the congressional inquisition that would greet moves by Yellen to raise short-term rates markedly? The Fed's QE program is depressing borrowing costs and helping Washington manage its debt load. The calculus would change rapidly if rates jumped. So would the outlook for stocks, which would weaken considerably if the Fed surprised the world with significant tightening efforts.

Marc Faber, Hong Kong-based publisher of the Gloom, Boom & Doom report, likens the market over the last 15 years to a relapsing alcoholic, and central banks to irresponsible bartenders. To dole out more booze, as monetary officials have been doing, is often the wrong medicine. But once you have numbed every sector of an economy, every asset class, every investor and every business with monetary hooch, whole nations can get hooked.

Take Japan. Even when the world's third-largest economy is churning out growth of, say 3 percent, it's artificial. Negligible rates sapped the urgency from Japan Inc. to reform at the very worst moment, just as it needed to keep up with a cast of growth stars in Asia, China included. The BOJ first cut rates to zero to support "zombie" companies and entire industries. But over time, this led to a zombification of a nation, a predicament that complicates Prime Minister Shinzo Abe's revival efforts. Kuroda's policies may be setting the stage for another 15 years of zero rates in Japan.

So go ahead and brace for a brutal few years of Fed normalization and financial sobriety. More likely, Yellen & Co. will be forced to leave the bar open indefinitely.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Willie Pesek at wpesek@bloomberg.net