Kristina Hooper, CFP®, CAIA, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Faced with debilitating deflation and anemic economic growth, Japan is the latest country to pursue financial repression as a way out of debt. But can the Fed’s model work for the Bank of Japan?
Japan’s central bank last week did what markets had been anticipating since November: it dramatically changed the course of its monetary policy under newly elected Prime Minister Shinzo Abe. What previously had been baby steps toward quantitative easing has become full-on, aggressive quantitative and qualitative easing. The Land of the Rising Sun is now yet another developed country caught in the tight embrace of financial repression.
In terms of quantitative easing, Japan plans to double its monetary base by buying yen and government bonds. Under its qualitative easing measures, Japan will double the average maturity of its government bonds from slightly less than three years to about seven years and accelerate purchases of ETFs and domestic REITs in order to bring down risk premia (lending rate minus T-bill) across all asset classes. Gone are the baby steps that have characterized Japanese monetary policy for well over a decade. Japan is clearly trying to play catch-up with the kind of repressionary monetary policies that have been in place with other developed central banks, particularly the Federal Reserve, for the past five years.
Japan could clearly use some help. It’s among a number of advanced economies with a debt-to-GDP level above 90%, which is typically viewed as the “debt intolerance level.” In other words, public debt is presumed to have an adverse impact on economic growth when it rises above that threshold. In fact, Japan has the highest debt-to-GDP ratio in the world at an estimated level of 212% in 2012, well above Greece at 162% and much higher than the US at 102%. So it’s imperative that Japan reduce debt and get its economy back on track.
There are certainly several different options available to countries that want to delever. Austerity is one option, but it is not well-liked, as evidenced in recent elections in Italy and France where pro-austerity candidates proved unpopular with voters. Just last week, Portugal’s high court struck down some austerity measures imposed by the government this year—a blow to the prime minister—who will now have to come up with an alternative plan for lowering the country's deficit or risk being cut off from its international bailout. Growing their way out of debt is not an option for many countries, including Japan, because they haven’t been able to achieve substantial economic growth for many years. So if a country doesn’t want to default and can’t restructure its debt, then financial repression becomes the least harmful choice.
While Japan has arguably had financial-repression-friendly monetary policies for some time—the BOJ embarked on quantitative easing more than a decade ago—they have been relatively mild. As a result, the central bank’s previous leadership team had been criticized by Prime Minister Abe and BOJ Governor Haruhiko Kuroda, who argued that such a tempered asset-purchase program hasn’t been effective. They’ve urged the central bank to focus on dramatically expanding quantitative and qualitative easing in order to juice the economy and combat deflation, which has plagued Japan for over two decades. Deflationary conditions have discouraged people from spending and companies from investing, resulting in very sluggish growth. Abe and Kuroda believe that an “easy money” policy can depreciate the yen, making its exports more desirable, and therefore stoking the economy. In addition, they believe these policies can bring about moderate inflation, which can boost domestic consumption. It should come as no surprise that Japan has gone full throttle into financial repression.
Yen Can Fall
With that backdrop, it’s also not surprising that the BoJ’s announcement was met with enthusiasm by investors, who bid up stocks. In fact, since this change in monetary policy was first anticipated back in November, the Nikkei has risen substantially and the yen has fallen quite significantly. There are certainly many critics who are worried about such unconventional, activist monetary policy. For example, hedge fund titan George Soros has noted concerns that the yen could free fall given the dramatic monetary stimulus, which rivals the heft of the Fed’s stimulus but for an economy that is one-third of the size.
However, International Monetary Fund chief Christine Lagarde applauded the move: “Monetary policies—including unconventional measures—have helped prop up the advanced economies, and, in turn, global growth. The reforms just announced by the Bank of Japan are another welcome step in this direction.”
In our view, Japan’s short-term situation remains positive. In the medium-term, we believe Japan’s aggressive monetary policy has to be combined with structural reforms—the tougher part of Japan’s agenda—in order to successfully create a sustainable economic recovery. So far, Japan’s macroeconomic data mainly show an improvement in sentiment, not activity. Still, we expect to see activity data gradually improve over the next few months. While our current GDP growth estimate for 2013 is 1%, we know Japan’s experiment in financial repression must be monitored closely to see if it achieves its goals.
This dramatic policy shift underscores the belief that financial repression is spreading and remains quite aggressive, calling for investors to understand its implications—specifically with regard to asset allocation and how risk has been redefined.
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