A cunning plan
Apr 5th 2013, 12:13 by Buttonwood
SO THIS is Japan’s national problem. The country has a lot of debt, much of it issued by the government. On the plus side, nominal interest rates are low, making the debt easy to service (albeit that interest costs are a quarter of government spending, see Andy Xie’s analysis). On the negative side, those low interest rates are a reflection of a deflationary, slow-growth environment that means its debt isn’t going to disappear.
Bring forward the cunning plan. Generate inflation and consumers will start spending, business confidence will improve and growth will resume. This will reduce the government’s annual deficit and reduce the real value of the debt over time. Problem solved. But what about investors? Won’t they demand a higher yield to compensate for the inflation? Marty Feldstein reckons a four percentage point rise in borrowing costs will push the annual deficit to 20% of GDP (admittedly, because of the average maturity of the debt, that would take some time to occur).
But no matter, because the central bank will buy a lot of the debt; it is both indifferent to the price it pays (and the return it gets) and has a theoretically infinite balance sheet. But isn’t this monetising the government debt? Not according to Gavyn Davies, writing in the FT, who says that
This is not helicopter money because the rise in JGB holdings (although more than large enough to finance the budget deficit in the next two years) is intended to be reversed in the long run.
The interesting question is whether outside investors should believe this. Mr Davies reckons the Bank of Japan will buy around 15% of GDP in the form of just long-term bonds, out of total bond purchases worth around 26% of GDP. In other words, whenever the BOJ offloads its bonds (whether it sells them outright, or doesn’t repurchase them when they mature, it makes no difference), the private sector will have to absorb the surplus. Over five years, that would be 5.2% of GDP each year on top of the running deficit the government would have to finance. Worse still, investors would then be aware that the BofJ would no longer be a buyer so the rise in yields would be substantial.
No matter, some will say; better to deal with the current crisis and worry about a future problem when it happens. But of course, there was a past taboo against central bank financing of government debt because it is very habit-forming; why bother raising money from angry taxpayers or skittish private sector creditors when you can just get your friendly central bank governor to lend it you? It is easy to think this finance is costless but there must be a cost; those who pay the cost may simply be unaware of it for a while (eg the financial repression levy).
Still while one can hold down bond yields, there is nothing to stop investors from reacting in a different way and selling the yen. George Soros worried about a yen plunge yesterday saying that
If the yen starts to fall, which it has done, and people in Japan realise it’s liable to continue and want to put their money abroad, then the fall may become like an avalanche
Of course, a certain amount of yen devaluation will be welcomed by the Japanese government since the prime minister called for it in December. The yen fell more than 3% against the dollar yesterday. Bill Gross said that so much yen devaluation will be needed to generate the desired inflation that other countries will complain about the trade competition.
Many will say that this is a domestic reflation policy, not a plan to boost Japan’s exporters (perish the thought). Mr Davies notes that
(Nor) is it overt exchange rate manipulation Swiss-style. Having flirted with a policy of deliberately buying foreign bonds, the BOJ and the government have not pressed this button yet.
However, I rather like this tart FT paragraph by Ben McLannahan and Chris Giles
Central bankers in developed economies say action aimed at boosting a domestic economy does not represent an aggressive act, because the aim is not to move the currency, even though that might be a side-effect. It is very different, they say, from direct management of currencies, such as China’s exchange rate policies, which they see as beyond the pale. Emerging economies tend to see this as semantic nonsense – a distinction without a difference.
In any case, Japan’s growth may be constrained by other factors than monetary policy, such as demographics and poor labour market policies, as Stephen King of HSBC notes. Another issue is that, as this blog has noted before, a devaluation is a fall in a country’s standard of living; it costs more to buy imported goods. In Britain, weaker sterling has led to above-target inflation and a squeeze in real wages. Mr Abe might find himself unpopular at home, as well as abroad, if a plunging yen eats into his citizens’ spending power.