Haruhiko Kuroda doesn’t wear a wizard’s hat when he arrives at Bank of Japan (BoJ) headquarters each morning. Once inside, I do wonder if he dons a cloak, waves a magic wand and concocts mysterious potions.
Kuroda has done something truly supernatural in his five months as governor of the central bank. The more yen he conjures up to produce inflation, the more he mesmerizes markets. Investors are more bewitched by Kuroda than they are by the number 1,000,000,000,000,000. The 15 zeros now needed to express Japan’s national debt almost have a dark-arts quality all their own. Yet a week after Japan’s IOUs reached the 1 quadrillion yen ($10.28 trillion) mark, yields have actually declined.
What is Kuroda’s secret? Ben Bernanke at the Federal Reserve would love to know as he fends off bond vigilantes, that mysterious cast of characters who protest fiscal or monetary policies they deem dangerous. Kuroda is winning bondland’s full obedience with two forms of trickery. The first is what economists call financial repression—essentially transferring money via monetary policy from citizens to the government. The second is outright monetization of public debt.
Of course, Kuroda can’t admit he’s engaging in either practice. The first would anger Japan’s 126 million people; the second might have hedge funds the world over shorting Japanese government bonds and credit-rating companies pouncing. So far, Kuroda is getting away with it. The longer he does, the better the chances Prime Minister Shinzo Abe can pull off his own miraculous feat of deregulating the economy.
It all depends on how long investors are willing to suspend their disbelief over the facts in Japan: an impossibly large debt load, an aging population and a propensity for political paralysis. Were that moment of clarity to arrive, the global economy would be shaken by the worst debt crisis in history. Forget Greece—Japan’s debt burden is larger than that of Germany, France and the UK combined.
The entire world has a vested interest in Kuroda keeping the magic alive. Last month, deputy economy minister Yasutoshi Nishimura admitted something quite profound: This is the last chance for Japan’s economy. Many worry Kuroda is hastening what they see as Tokyo’s demise. Hedge-fund manager J. Kyle Bass, whose Hayman Capital Management LP has been predicting a Japanese collapse since 2010, is now surer than ever in his bet.
The usual argument against a crash is that well over 90% of government debt is held domestically, eliminating capital-flight risks. But that doesn’t explain how Kuroda has so masterfully silenced the vigilantes. Remember the violent yield swings of May and June? Ten-year yields now sit docile at 0.74%. That compares with 2.76% in the US, which prints the world’s reserve currency, holds a higher credit rating and boasts a growing population.
Sure, Kuroda crushed the skeptics with overwhelming monetary force. But the powers of financial repression deserve far more credit. The yield volatility that accompanied the first wave of Kuroda’s doubling of the monetary base in April shook Japan Inc. to its core. Government bonds are the main financial asset held by banks, companies, pension funds, universities, endowments, insurance companies, government-run institutions, the postal-savings system and individuals. Rather than reduce their debt exposure, the Japanese doubled down.
Kuroda didn’t exactly tell them to do so—it was more a matter of spin, with no direct Bank of Japan fingerprints. Bondholders got the message that it would be in everyone’s best interest to keep a lid on debt yields. What some might label a pyramid scheme, Japanese view as financial security. This dynamic is accelerating a huge redistribution of wealth within society from creditors (the people) to debtors (Japan’s ministry of finance). That’s pushing inflation-adjusted interest rates even further into negative territory and giving the government cheaper financing.
Monetization is clearly part of the mix. Again, Kuroda can’t admit to being the ministry of finance’s ATM. But the BoJ is buying up ever-bigger portions (more than 70%, in many cases) of government debt at auction. What the BoJ does with much of that debt might never be known. Kuroda admits that he’s learned from Korekiyo Takahashi, the 1930s finance minister whose unorthodox policies earned him a reputation as Japan’s answer to John Maynard Keynes. In June, Abe said Takahashi’s exploits emboldened him to get radical.
Monetizing debt is the worst scenario economists like Milton Friedman could imagine. But then, who really thinks an aging nation carrying a debt approaching 250% of gross domestic product can ever repay it? Who actually thinks doubling the consumption tax to 10% will slay this beast? That’s why Kuroda’s end goal may justify the means.
Things could still go terribly wrong. If Abe’s big talk of structural reform isn’t met with action, then Kuroda is creating the biggest bubble in history. Should the bond vigilantes get a peek behind the curtain at what the wizard of Tokyo is really up to and panic, then Japan will face devastating problems. For now, though, Kuroda’s magic tricks are working, and they’re a wonder to behold. Bloomberg
William Pesek is a Bloomberg View columnist.