Market Hype on Perpetual JGB after Abe-Bernanke Meeting. BOJ Cornered by Market--Needs a Bold Move.
August 20, 2016
It is not a specter of summer night.
Bank of Japan ("BOJ") to supply unlimited sum of money as if throwing bills from helicopter; the idea of helicopter money is haunting Japanese skies. Irritated by never accelerating economy, Abe administration may pick a forbidden fruit. This fact illustrates how Japan's economic policy steering is closing towards a critical zone.
On July 12th, a man of news visited the Prime Ministerial Office: Former Federal Reserve ("FED") Chairman Ben Bernanke, who has been known as a proponent of "helicopter money". Market participants in and out of Japan read the meeting as Bernanke's lecture to Abe on his pet policy. Yet, the person familiar with the meeting says, "the meeting did not contain any words on helicopter money". Yoshihide Suga, the cabinet secretary and the key policy planner of Abe Administration denied helicopter money as a topic in that meeting, but, the hype did not subside. The person behind the move was Etsuro Honda, former Special Advisor to the cabinet, now ambassador to Switzerland. He took advantage of a Tokyo lecture by Bernanke sponsored by PIMCO, a U.S. fund management firm, and set him introduced to the prime minister in order to further boost Japan's monetary policy.
Honda Pitched Screwball from Switzerland
We felt a Deja-vu, as Honda introduced Paul Krugman, professor emeritus of Princeton, to Abe in November 2014, when he was invited by Daiwa Securities Group, with an intention of relying on his academic fame to postpone then-hot issue of a rise in consumption tax. He used the same ruse this time. Honda even wielded an influence on recent nomination of BOJ policy board member, and a BOJ official grumbles; "board members are now hand-picked by the Prime Ministerial Office". This BOJ man was "a bit relaxed because Mr. Honda went to Switzerland as an ambassador", but a screwball was pitched from Switzerland.
Markets hyped with helicopter money, and 10 year JGB yield turned deeply into negative zone to minus 0.3% in July 29th, just before the BOJ Policy Meeting and yen was once sold down to 106 yen per dollar. Market read BOJ could not be hesitant for new actions when deflation taking toll of the economy as consumer price index again turned negative year-on-year.
The government was also expecting more monetary action. Abe Administration publicly announced in August 2nd that it would introduce a "large-scale economic package", meaning some fiscal stimulus, thereby asking BOJ for further coordinated easing. As expectation snowballed, led by Haruhiko Kuroda, the governor, BOJ acted, but that was unintelligible. From that day on, markets of stock, bond and forex random-walked. On July 29th, BOJ announced an annual doubling of investment on exchange traded funds ("ETF") amounting to 6 trillion yen. The move itself constituted further easing, but no action on negative interest or no increase on JGB purchase were insufficient from the market point of view. Moreover, the content dubbed as "beefing up monetary policy" contained "a comprehensive review" will be taken place at next policy meeting in September.
A comprehensive review? Markets stumbled on this unintelligible wording. It could be interpreted either of "further easing", or "framework of easing to be changed", or "retreat from the easing policy". The delicate tone of the wordings heightened suspicions of the market participants.
Negative Rate Backfired to Banks
"Realizing 2％inflation rate in 2 years". Governor Kuroda declared in April 2013, and advanced to the "different dimension relaxation" of annual purchase of 50 trillion yen JGB from market, dubbed as "Kuroda Bazooka". As a kick-start, the magic of Abenomics realized weaker yen and stronger stock price, and consumer price index turned positive, thus Kuroda magic might have come true, many thought so. Yet, after the consumption tax rise of April 2014, economy and price index gradually lost steam.
Then, Governor Kuroda stepped up the easing in October 2014 with Kuroda Bazooka 2.0. The JGB annual purchase limit was raised to 80 trillion yen, which was explained as an encouragement to realize pay rise in spring 2015. Kuroda also supposedly intended to support a rise of consumption tax. With this move, the Abe Prime Ministerial Office felt the shadow of Ministry of Finance ("MOF"), Kuroda's former employer.
Yen was getting weaker, and food price increased. Consumers felt pinch by demerit of weaker yen, and the government and the ruling parties no longer requested further monetary easing. In the lower house election of December 2012, when the Liberal Democratic Party("LDP") recaptured power from Democratic Party of Japan("DPJ") for the first time in 3 years, Mr. Abe committed an "unlimited monetary easing", but calls for exit from deflation apparently weakened. As a result, BOJ experienced a betrayal of the government.
The game changed dramatically in the beginning of this year. Dwindling Chinese economy, financial instability in Europe, and possibility of U.S. rate hike retreating, brought about stronger yen and weaker Japanese stocks. Fiscal 2016 budget was in Diet for discussion, thus fiscal stimulus was eliminated from policy alternatives. Then, the BOJ moved in January 29th, introducing a "negative interest rate policy" by charging a fee on a part of current deposits of commercial banks at BOJ. The policy objective was to stop stronger yen, and to avoid stock market meltdown towards the fiscal year end of March, but it went awry. The U.S economy started to falter, and chance of another rate rise by the FED led by Janet Yellen got remote. Moreover, as the negative interest policy made yield curve flat, therefore banks' yield spread from deposit and lending disappeared quickly, and institutions such as life insurance companies were threatened by deteriorated investment yields.
By definition, BOJ's monetary policy seeks permeation of objective through financial institutions. But, relationship with financial community was devastated, as Bank of Tokyo Mitsubishi UFJ requested a withdrawal from JGB primary dealership. Thus the policy intended to improve economy and stock market backfired, and private financial community called BOJ as a "war criminal". Also, consumer price index started to inch down.
Different dimension easing of JGB purchase to increase money, and the negative interest policy of charging fees to BOJ current account of banks, both policies implemented by Kuroda BOJ eventually hit obstructive walls. The rampant rumors on helicopter money is nothing but a manifestation of frustration of market participants on Kuroda BOJ's deadlock.
Then, what is a difference of helicopter money and ordinary monetary easing? The original proponent of the helicopter money was Milton Freedman, the architect of monetarism. He employed the concept as central banks to print bills and distribute them by helicopter. His apprentice Ben Bernanke once proposed helicopter money to Japan in 2003, when he was a member of Fed board. The government to issue bonds to implement tax reduction, and the bonds would be bought by BOJ and it would announce to hold bonds eternally--- this is what Ben Bernanke introduced in a keynote speech of Japan Society of Monetary Economics held at Hitotsubashi University in spring 2003.
No Interest Perpetual Bond Recommended by U.K. and U.S.
BOJ printing bills--part of JGB held eternally--government to reduce tax by that money. By simplifying the procedures, BOJ would throw around bills to citizens, and that overlaps with the basic form of helicopter money depicted by Freedman.
The helicopter money imagined by Bernanke is not a simple fiscal finance by BOJ, but can be recognized as a massive total demand stimulus--energizing consumption and investment―, required in depression or grieve deflation.
Households tend to preserve consumption with a fear of tax increase to pay down bond, even if government reduces tax by issuing bonds; this is a neutral proposition by David Ricardo. If that is the case, why not the central bank to hold the bonds eternally, Dr. Bernanke twisted the proposition. No need for the government to increase tax by securing redemption of bonds, thus stimulation effect to consumption and investment would be bigger.
It is not only Dr. Bernanke who insisted on the helicopter money. Sir Adair Turner, former head of British FSA also proposed helicopter money to Japan. With condition precedent set at 2% inflation rate, he proposed a part of BOJ-held JGB to be exchanged to perpetual non-interest bearing bond. The government will be exempted to pay down bonds partially, and the new JGB to be issued, and use the proceeds to stimulate economy.
According to Mr. Honda's accounts, when he met Dr. Bernanke April this year in New York, he was suggesting an idea of non-interest perpetual bond. That must be a source of current hype. Economists at foreign investment banks all agree that "starting spring this year, we received many questions on helicopter money or perpetual JGB".
Such a helicopter money hype works both good and bad to Abe administration. Bad side is, people may feel that Japan being that cornered. But, including Mr., Honda, the real feeling at the Prime Ministerial Office must be "if you drink poison, eating plate is nothing".
JGB Purchase is in Limit, but cannot be reduced
At this moment, regular monetary easing and aggressive fiscal stimulus may be the only policy package. Indeed, that sounds like a much-used tea bag, surely to incur market disappointment. If that is the case, providing same drinks of monetary and fiscal liquors in new leather bag named helicopter money sounds refreshing. If there is a hype in market, be it persist, without denying: This must be a candid feeling at the power center.
Kuroda BOJ has a very delicate position. If it accepts the helicopter money, it would be an outright breach of section 5 of the Fiscal Law. That is the reason Governor Kuroda denies helicopter money, if asked in front gate.
On the other hand, since the consumption tax rise of April 2014, BOJ has been bearing all burdens of supporting Japanese economy. Furthermore, the negative rate policy created after a hard labor has been unpopular at best. Therefore, implementing further easing coupled with fiscal stimulus of the government may be effective, and burden of BOJ may be smaller, the BOJ officials must have thought that way.
In the Q&A of July 29th, Governor Kuroda reiterated on "policy mix of monetary and fiscal". We understand his feeling, but in reality, BOJ buys 80 trillion JGB while annual issuance stands at 30 trillion yen. If this pace continues, JGB will drink up all bonds. At the same time, the commitment of 2% inflation target within 2 years is way remote over mirage. BOJ one way or the other needs to commit suicide with JGB, fixed income people thought so, and gotten impatient.
It is MOF, the issuer of JGB, who afraid most of a revolt in bond market. Therefore, sensing market instability right after July 29th it swiftly set a meeting between Taro Aso, the finance minister, and governor Kuroda in the evening of August 2nd. The objective of the meeting was a demonstration of hand-in-hand relationship of MOF and BOJ so as to fend off panic sale at the JGB market.
Of course, some BOJ officials are aware of the danger of JGB purchase without exit path. A plan of changing target with a band of 70 to 90 trillion yen surfaces and disappears from time to time. Yet, it is tricky, as some policy board members fears, the market most likely react negatively if the amount of purchase were cut from the current 80 trillion.
Helicopter money per se is impossible, but a policy close enough to be regarded as the helicopter money, or a "mock helicopter money" may be a compromise. The implication is, in short, that BOJ easing has no exit path at all.