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Japan Shows QE Exit Is Easier Said Than Done


It's likely that Japan can do little more than persist in the policies that have failed it for more than 15 years.

Japan's long-running experience with near-0% interest rates, lackluster economic growth, dismal long-term stock market returns punctuated by extravaganzas such as 2013's 28.23% return in USD terms, and spectacularly low long-term interest rates accompanied by breathtakingly negative short-term real interest rates poses the question as to when it all will be over.​
Are Those Real?
First, let's take a look at those negative rates and how they have changed so far in 2014.  Even though these rates are far more negative now than they were at the start of the year, a surefire sign that the supply of yen has been growing faster than the demand therefor, the yen itself has gained 3.82% against the dollar and 6.9% against the Chinese yuan.  It is also a surefire sign Japanese investors have increased their demand for cash balances -- a disinflationary development.

Eleven Years After

Those very same risk-averse investors are willing to pay the Japanese government for the privilege of lending it money.  Remember, Japan's ratio of debt to GDP is approaching 250%, but once those numbers cross 100%, they become increasingly meaningless.  I have to marvel at US deficit scolds' continuous warning that our debt will have to end in ruinous inflation and higher interest rates when Japan's public debt has led to persistent deflationary pressures and those negative real rates noted above. Lost in translation, I guess.
If we map 10-year Japanese government bond yields since Japan first went to its zero interest rate policy (ZIRP) in February 1999, we see how they moved down to 43.8 basis points in June 2003, doubled from that level by July 2003, and after several years of meandering, entered their present downtrend in the second half of 2008.  They are trading just under 60 basis points as I write.

Given this environment, can Japan do anything other than persist in the policies that have failed it for more than 15 years?  I doubt it; Japan tried to renormalize short-term rates in the spring of 2006 only to back away as yen carry trades around the world unwound.  If the yen is rising in the face of falling real rates now, what would it do if the supply of yen started to diminish?  And if growth is weak now, what would it look like if the government's debt service costs started to rise?
I think Japan is trapped. Worse, I think we have wandered into the same tar pit and will encounter the same problems if and when we start to renormalize interest rates.
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