Ten years from now, will Bank of Japan Governor Haruhiko Kuroda be regarded as a genius or a madman?
Kuroda's shock-and-awe stimulus move on Oct. 31 delighted markets and won him plaudits as a monetary virtuoso. Japan, the conventional wisdom tells us, has finally gotten serious about ending deflation, and isn't it wonderful. But what happens when a central bank buys up an entire bond market? We're about to find out as Kuroda, like some feverish hedge fund manager, corners Japan's. Neglected in all the celebrating: To reach a 2 percent inflation goal that's both arbitrary and meaningless, the BOJ is destroying Japan's standing as a market economy.
In announcing that it will boost purchases of government bonds to a record annual pace of $709 billion, the central bank has just added further fuel to the most obvious bond bubble in modern history -- and helped create a fresh one on stocks. Once the laws of finance, and gravity, reassert themselves, Japan's debt market could crash in ways that make the 2008 collapse of Lehman Brothers look like a warm-up. Worse, because Japan's interest-rate environment is so warped, investors won't have the usual warning signs of market distress. Even before Friday's bond-buying move, Japan had lost its last honest tool of price discovery. When a nation that needs 16 digits in yen terms to express its national debt (it reached 1,000,000,000,000,000 yen in August 2013) sees benchmark yields falling, you've entered the financial Twilight Zone. Good luck fairly pricing corporate, asset-backed or mortgage-backed securities.
Considered in relation to gross domestic product, Kuroda's purchases make the U.S. Federal Reserve's quantitative-easing program look quaint. The Fed, of course, is already ending its QE experiment, while Japan is doubling down on one that dates back to 2001. Kuroda's latest move means Japan's QE scheme could last forever. The BOJ has willingly become the Ministry of Finance's ATM; reversing the arrangement will be no small task.
All this liquidity has made for surreal events in Tokyo. Take the news that Japan's $1.2 trillion Government Pension Investment Fund will dramatically rebalance its portfolio away from bonds. Japan has enormous public debt and a fast-aging population, and now the world's biggest pension pool is shifting to stocks. Yet somehow, 10-year yields are just 0.43 percent. The explanation, of course, is that the parts of the market the BOJ doesn't already own are sedated by its overwhelming liquidity. The BOJ is now on a financial treadmill that's bound to accelerate, demanding ever more multi-trillion-dollar infusions to keep the market in line.
To Japan bulls, the end justifies the means. If Kuroda changes the deflationary mindset that's stalked Japan for 17 years now, then his gambit was worth it. One problem with this argument is that deflation isn't the cause of Japan's malaise, but a side-effect. Consumer prices rising at 2 percent or more will be a big problem if Prime Minister Shinzo Abe doesn't push ahead with plans to deregulate the economy and prod companies to raise wages. That's doubly true as Tokyo mulls another growth-denting rise in the consumption tax.
Another problem is that Kuroda is turning the BOJ into the world's biggest asset-management company. The BOJ won't admit it, but it's monetizing Japan's debt on a massive scale, and probably even retiring large blocks of it -- just as the government did in the 1930s. What happens when the BOJ decides Japan needs a credible and functioning bond market in the years ahead? Kuroda's successors face terrible odds disengaging from a market he's effectively nationalized.
Perhaps history will vindicate Kuroda's genius. That depends on whether Abe musters the courage to attack structural impediments to growth in employment, industry, trade and energy. More likely, Kuroda is demonstrating that it's one thing to go long on a market, and quite another if you have to stick with that bet forever. To avoid being remembered as a madman, Kuroda had better devise an exit strategy from history's most audacious bond trade.
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