Full throttle for Kuroda’s helicopter

IFR 1978 6 April to 12 April 2013
6 min read
Jonathan Rogers

Jonathan Rogers, IFR Asia Senior Credit Analyst

Jonathan Rogers, IFR Asia Senior Credit Analyst

NEWLY-APPOINTED BANK OF Japan governor Haruhiko Kuroda shocked financial markets last week by announcing the most radical quantitative easing programme ever introduced, setting off in the process a knee-jerk spike in the dollar/yen exchange rate and in Japanese equity markets, and a collapse in Japanese government bond yields to all-time lows.

Who would have thought it? Certainly no one at IFR Asia who interviewed Kuroda when he headed the Asian Development Bank. Meetings there were conducted with the utmost formality and questions answered in a sotto voce tone that was often inaudible.

“Helicopter Kuroda” would have seemed an unlikely proposition had we known of his future appointment at the BoJ’s helm. But it’s the epithet last week’s dramatic action will earn him after he announced a ¥1.4trn (US$14.7bn) quantitative easing programme, a doubling of Japan’s monetary base, and the purchase of REITs and ETFs. The aim is to push the country’s inflation rate up to 2% and pull the country out of its decades-long economic morass.

It didn’t take long for the pundits to chip in with their two pence worth on the implications of Japan’s proposed QE, which is roughly three times the size of the US version under QE3. George Soros suggested that the action, which he described as “a sensation”, could lead to an “avalanche” in the yen as Japanese investors look to invest abroad, spurring massive capital flight from the depreciating currency.

I’M REMINDED OF Harold Wilson’s comments from the late 1960s when the pound was devalued a full 14% as Britain sought IMF assistance. He told the British public that “the pound in your pocket or purse or in your bank” would retain its value. There was some truth in that and I’m not sure that the average private investor in Japan is in the game of shifting savings out of the yen to take advantage of foreign exchange movements. The biggest impact, as it was for the average Brit back in 1967 after the pound’s devaluation will be that foreign holidays will become more expensive. But does the ageing population of Japan take foreign holidays?

If quantitative easing didn’t do the trick back then it’s difficult to see why it will be any different this time around

Next it was the turn of Harvard professor Niall Ferguson, who pointed out that Japan’s ageing population demographic mitigates against the economic growth Kuroda’s QE programme is designed to achieve. So the inculcation of an inflationary mindset in Japan, such that rather than deferring purchases because prices are going to be cheaper in the future, you start buying because they’re going up, won’t spur consumer spending – unless perhaps it’s on stairlifts or Zimmer frames. Japan is a low-growth economy and the Kuroda helicopter won’t be able to do anything to fix that, period.

Demographics aside, you can’t blame Kuroda, nor prime minister Shinzo Abe who has leant on the new BoJ governor to produce last week’s measures, for wanting to take radical action. But the real issue is that monetary policy no longer works in the way it is supposed to in Japan – or, for that matter, in the US.

WITH JAPAN EXPERIENCING a balance sheet recession, in which companies and households deleverage and pay down debt, even at zero interest rates, no one wants to borrow. In the US, the massive liquidity injections following the 2008 crisis tripled the country’s monetary base, but money supply remained stagnant. In Japan, which doubled its monetary base between 1997 and 2006, having instituted quantitative easing in 2001 and kept it going until 2006, money supply as measured by M2 and bank lending actually fell 37%. Meanwhile, although inflation in Japan crept up to 2% soon after the 2008 financial crisis, the deflation which had been the norm for much of the previous 15 years soon returned and continues to dog the country.

According to Nomura economist Richard Koo, who coined the term balance sheet recession, if the Japanese government hadn’t stepped into the breach by spending where households and corporate did not, the country would have fallen into a slump worse than the Great Depression. If quantitative easing didn’t do the trick back then it’s difficult to see why it will be any different this time around.

Perhaps the ingredient that might make it work is the level of Japanese government bond yields. Kuroda said last week that the BoJ will make annual purchases of JGBs totalling ¥50trn (US$520bn) a year. The 10-year JGB yield compressed over 20bp to an all-time low on that news. With Japanese banks holding an estimated 900% of their Tier 1 capital in JGBs – compared to 25% for UK banks’ gilt holdings and 100% for US banks’ Treasury inventory – and earning a microscopic return on these holdings, perhaps they will go on a concerted mission to start more profitable lending and kick-start the Japanese economy.

The irony, of course, is that Japanese banks park so much in JGBs because their lending books are under-utilised because no one wants to borrow. If the BoJ succeeds in meeting its 2% inflation target, the resulting slide in JGBs will inflict massive damage on Japanese banks’ balance sheets – unless Kuroda’s bond-buying plan succeeds in delivering the highest negative real interest rate around. That remains to be seen, but there’s no doubt he’s playing a high-stakes game.

Jonathan Rogers with border 220
Jonathan Rogers