Recently, we faced an unprecedented economic event. Earlier this week, Japan’s 10-year government bond yield dipped below zero for the first time ever. This remarkable shift has been decades in the making, as a result of extensive intervention in the financial markets.
On Tuesday, as the Nikkei index plummeted over 5 percent, the yield on Japan’s 10-year government bond fell to minus 0.005 percent. This historic occurrence marks the inaugural instance of a G7 country’s 10-year bond yield dropping into negative territory. It is indeed surreal to witness such absurdity.
Just a few short years ago, such low bond yields seemed unimaginable. Why would anyone willingly lend money at a loss, particularly when they anticipate negative outcomes? Nevertheless, we find ourselves in a reality that defies previous logic.
What does this mean for the future? The consequences of having a 10-year government bond with a negative yield remain unclear, yet it raises intriguing questions. Will this development enable the government to issue and purchase unlimited amounts of its own debt?
To be candid, aside from the fact that bondholders will incur a fee for the privilege of lending money to the Japanese government for a decade, the implications are uncertain. However, we can share some reflections.
The Beatings Will Continue
Recall Prime Minister Shinzo Abe, the mastermind behind the Bank of Japan’s Abenomics. He has championed aggressive policies aimed at stimulating exports through currency depreciation. The belief was that a weaker yen would provide Japan with a competitive edge, allowing it to import world wealth while exporting their way to prosperity.
We may be missing something here, but how does diminishing the savings of a nation lead to increased wealth for that nation?
In our view, devaluing one’s currency is akin to provocation; it invites trouble. The temporary gains are soon overshadowed by the fallout, where initial euphoria turns into long-term hardship.
Unfortunately, the consequences of currency devaluation—like agitating a formidable adversary—are not easily reversed. Abe’s actions regarding currency debasement have gone far beyond the point of no return, and the repercussions are now glaringly evident.
Moreover, the turmoil will persist until there’s a notable turnaround. For instance, Japan’s GDP contracted by 1.1 percent in December, alongside a disappointing 3.2 percent drop in exports—supposedly the beneficiaries of Abenomics.
Less than Zero
What is the situation here? Wasn’t the intent of devaluing the yen to enhance national morale? Shouldn’t Japan’s newfound wealth be generating significant benefits?
In theory, perhaps. However, the reality has been starkly different. The variables at play are simply too numerous and unpredictable for policymakers to navigate effectively. The negative yield on the 10-year government bond results largely from the negative interest rate imposed by the Bank of Japan on deposits.
For further insight, we turn to Paul Vigna from The Wall Street Journal…
“A negative yield on Japan’s 10-year was a fait accompli following the policy decisions made by the Bank of Japan. The buyers of these negative-yield bonds aren’t typical investors, but rather large institutions, primarily banks, seeking a secure place for their funds. As the Bank of Japan set a negative deposit rate of 0.1 percent, these banks turned to government bonds as the next safest option.
“It’s worth noting that Japan’s 10-year yield didn’t just plummet from 5 percent to negative. Even before the global financial crisis, it remained under 2 percent. Ironically, the policies intended to encourage lending have instead stoked fear.”
Who could have predicted that outcome?
Certainly not the Bank of Japan. Similarly, the European Central Bank and the Federal Reserve would face the same oversight. Unintended consequences often accompany innovative policies. Clearly, the Bank of Japan is at the forefront of this economic experiment, paving the way for future practices that other central banks may eventually follow.
Nonetheless, it appears that the markets have already taken their cues. As of yesterday, the yield on the 10-year Treasury fell below 1.6 percent. It’s only a matter of time before it, too, descends into negative territory.
Ultimately, we will all have to contend with the repercussions.
Sincerely,
MN Gordon
for Economic Prism
