The Economics Of Less than Zero

Just when we thought we’d seen it all the impossible happened.  Earlier this week the 10-year Japanese government bond slipped into negative.  Obviously, it took decades of heavy handed intervention into credit markets to pull off such a feat.

On Tuesday, when the Nikkei dropped over 5 percent, the yield on Japan’s 10-year government bond dropped to minus 0.005 percent.  This marked the first time in the history of government debt that the yield on a G7 country’s 10-year bond has been less than zero.  We are lucky to be alive to bear witness to the absurdity.

Just a few years ago these depressed credit prices would’ve been considered impossible.  Why would anyone with advanced knowledge of a negative outcome loan their money at a loss?  But sure enough, in the bright light of day, the impossible has become reality.

Make of it what you will.  The ultimate impact of a 10-year government bond with a negative yield is unknown…though something seems amiss.  Will this allow the government to issue, and also buy up, unlimited amounts of its own debt?

Quite frankly, aside from the notion that bond holders will pay a fee for the privilege of loaning money to the Japanese government for a decade, we really don’t know the implications.  Still, we can offer some reflections.

The Beatings Will Continue

If you recall, Prime Minister Shinzo Abe, the brainchild behind the Bank of Japan’s Abenomics, has pursued a reckless policy to boost exports by trashing the currency.  A weak yen, it was thought, would give Japan a competitive advantage and allow them to import wealth from the world.  Conversely, by devaluing the currency, Japan would somehow be able to export their way to wealth.

Maybe we’re a bit dim, but for the life of us, we can’t quite seem to understand logic.  How does robbing the savings of a country’s citizens in turn make the country wealthy?

By our estimation devaluing one’s currency, like giving a Hells Angeles biker the middle finger, is asking for all kinds of trouble.  The brief pleasure it may bring will quickly be overcome when getting ones face beat to pulp.  That’s when the brief pleasure turns to long term pain.

Alas, the action of currency devaluation – or angering a big bad biker – cannot easily be undone.  So, too, Abe’s currency debasement actions are well past the point of no return.  The associated effects are now pummeling his country in the face.

What’s more, the beatings will continue until morale improves.  For example, Japan’s GDP contracted 1.1 percent in December.  In addition, exports, which were supposed to be the great beneficiary of Abenomics, fell 3.2 percent.

Less than Zero

What’s going on?  Wasn’t the purpose of debasing the yen to improve morale?  Wouldn’t the new abundance that should’ve flowed to Japan provide ample compensation?

Perhaps this is so, in theory.  But unfortunately it hasn’t worked out in practice.  The variables are far too many and far too unpredictable for policy makers to account for.  As it turns out, the negative yield on the 10-year government bond is being compelled by the negative rate the Bank of Japan is charging for deposits.

For edification, we turn to Paul Vigna at The Wall Street Journal…

“A negative yield on Japan’s 10-year was a fait accompli after the policy moves set in motion by the Bank of Japan.  The buyers of negative-yield bonds, after all, aren’t really average savers – the proverbial Mrs. Watanabe [Japanese housewife] – but rather large institutions, banks mainly, that need a place to park their money.  With the Bank of Japan setting a negative rate for deposits of 0.1 percent, the banks simply moved into the next safe haven – government bonds.

“It’s not like Japan’s 10-year just went from 5 percent to negative, after all.  Even before the global financial crisis, its yield was under 2 percent.  The policies these banks have imposed, though, designed to spur lending, are instead today spurring more fear.”

Who could have seen that one coming?

Certainly not the Bank of Japan.  The European Central Bank and the Federal Reserve would’ve had the same oversight.  For there are unintended consequences to ever clever policy imposed.  No doubt, the Bank of Japan’s out on the frontier pioneering the way.  Eventually, the Fed will follow their lead.

Regardless, it seems markets already have.  Yesterday the yield on the 10-year Treasury dropped below 1.6 percent.  Before long, it too will be less than zero.

Likewise, we’ll all have to live with the consequences.

Sincerely,

MN Gordon
for Economic Prism

Return from Less than Zero to Economic Prism

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