Last week, a tax accountant in Japan messaged me: “I’m afraid of the collapse of the Japanese economy…” Luckily, he speaks fluent English after a stint studying in California. But he hasn’t lost the Japanese habit of understating everything… I don’t think.
The message wasn’t entirely random. I’d asked him about the crashing yen and the latest outbreak of insanity at the Bank of Japan.
While the rest of the world is busy trying to bring down inflation thanks to a global energy crisis, the country which is famously dependent on importing energy is busily loosening monetary policy even more…
But, back to the Japanese tax accountant for a moment. Our conversation about Japanese monetary policy started a few months ago, as these things do, when we were out drinking in small-town Japan.
At the jazz-themed bar, I asked my friend, whose name means “three rounds” in Japanese, about Kuroda-san.
The head of Japan’s central bank is a household name in Japan. And being a household name is never a good thing for the head of a central bank. But, in this case, Kuroda-san is quite famous globally too. Which is really, really bad.
What makes Kuroda-san so special internationally, as far as I can tell, is a typical Japanese behaviour. It is usually misinterpreted by Westerners, leading to severe misunderstandings and, occasionally, marriage.
In Japan, laughter is about dealing with awkwardness.
Unless it’s a real belly laugh… but this article is about monetary policy, remember.
Usually, Japanese people laugh when you’re embarrassing yourself without realising it. It’s a warning that you’ve made some sort of mistake. The Japanese way to deal with the resulting awkwardness is to laugh politely to alert you of your error. Which doesn’t work.
How does this play out?
You think they liked your joke, but you’re actually on the “women only” carriage of the train. The joke just unleashes the pent-up awkwardness.
If Japanese people smile at you at the hotel, something is wrong. It’s probably because you’re still wearing the designated toilet slippers in the lobby.
Japanese people also laugh when they’re embarrassing themselves. Which only ever happens when they try to speak English, of course…
Now, Kuroda-san has a habit of laughing like a maniac whenever he tries to speak English. Which usually happens when he’s on Western TV making comments about Japanese monetary policy.
He thinks the laughter is making light of his broken English – a way to defuse any misunderstanding, excuse any miscommunication or avoid any unintended misinterpretation.
It’s a signal that people should sympathise with his embarrassment for his poor English skills, a way to apologise for not being able to express his meaning in the precise sort of way that central bankers are supposed to do.
Unfortunately, laughing like a maniac while discussing your own monetary policy for the world’s most indebted government is interpreted very differently by Western people…
Cue the collapse in the yen as the Bank of Japan tries to pin down Japanese bond yields.
We’ll get to how bad this crash is in a moment, and why it should scare you. First, consider the situation the Bank of Japan is in – it’s certainly no laughing matter.
Japan’s government debt is terrifyingly high. If interest rates rise, the cost of paying interest will be downright dangerous.
And so, the Bank of Japan is trying to cap government bond yields at 0.25%. In order to do this, it is buying as many government bonds it needs to in order to keep yields that low. It is both funding the government and keeping the government’s borrowing costs down in one massive quantitative easing (QE) exercise.
But financial markets aren’t buying it – either figuratively or literally. They don’t think the Bank of Japan can keep yields that low with energy prices triggering high inflation all around the world, even in places that export the energy Japan imports.
Even the Japanese tax accountant doesn’t believe the inflation statistics any more, he told me.
And so, investors are selling out of Japanese bonds in anticipation of the Bank of Japan having to raise interest rates and crash its own bond market as the authorities in the United States, the UK, the euro area and Australia have done.
For now, fighting the speculative attack on its government bond market is forcing the Bank of Japan to create vast amounts of yen to buy Japanese government bonds. And that increase in the amount of yen is causing its value to crash on foreign exchange markets.
The problem here is highlighted in the headline from Markets Insider: “The Japanese yen used to be a “safe haven”. But it has just crashed to a 20-year low”.
This causes a lot of different problems. The least of which is that my Japanese parents-in-law are retired and living in Barcelona at the moment…
The yen’s crash also disrupts trade because Japan is an export powerhouse, for example. But there are more interesting angles…
Japan lends a lot of money to the world. It has been the world’s top creditor for 31 years in a row!
So… instability in Japan is a major problem for anyone else around the world who is trying to finance themselves. Which is pretty much anyone, at this point, thanks to crashing bond markets just about everywhere.
For some reason, the Japanese have an old habit of funding the wrong sorts of people at the wrong sorts of times. Japanese investors piled into Asian debt before the Asian financial crisis, sub-prime CDOs during the housing boom and the wrong European sovereign debt before Europe’s sovereign debt crisis.
This happens because they like to look for a little more yield in exchange for taking on a little more risk: this is because their home bond market doesn’t get much yield thanks to the Bank of Japan’s long standing and mad monetary policy.
It’s called reaching for yield and it often results in your hand getting lopped off.
Higher yield types of investments are the ones to blow up when things go bad, while the safer bonds tend to perform well during such times.
So, instability in Japanese funding as Japan experiences economic problems is a real worry. It exposes the weaker borrowers to a lack of lenders at a crucial time.
But I also have some good news… for my in-laws in Barcelona. The euro is next on the block.
The European Central Bank (ECB) is going the way of Japan with its monetary policy – prioritising the affordability of government debt over inflation rates.
The ECB had an emergency meeting last week to discuss the European sovereign bond market chaos. The risk of the euro area falling apart is rising as the interest rates on government debt surge and the differences between German and weaker nations’ interest rates surge too.
The ECB considers it a part of its mandate to save the euro from falling apart. And the real question now is which mandate is more important – inflation or keeping sovereign debt in Greece and Italy affordable for those governments. Because the ECB, like the Bank of Japan, is being forced to choose.
If you’re not sure what the choice will be, consider that the ECB will likely cease to exist if the euro does…
There’s a deep irony here. For years, many people argued that the world will turn Japanese. This referred to slow growth, deflation, demographic implosion and economic malaise, not good food, high living standards or a lack of insulation in homes which requires heated toilet seats as a result.
But what if the “turning Japanese” crowd has it precisely backwards? What if Japan is leading Europe into an inflationary nightmare, not a deflationary one?
What if Japan is currently revealing that, when push comes to shove, central bankers will always back their mates at the Treasury over those of us who need our money to maintain its purchasing power?
That is, after all, what tends to happen historically. Not many currency systems have opted for government insolvency when faced with a crisis. They prefer to print and trash the value of the currency instead.
And so … I’d like to reassure my in-laws. The euro is likely to crash like the yen is doing now. They’ll be able to bring me chorizo for New Year after all.
What should my father in-law be focusing on instead of the crashing yen? That’s easy.
In times like this, bargains can be had in a little corner of the market which is beaten down, but unfairly so. Prices have dropped by association instead of based on fundamentals. And for these types of investments, it’s all about fundamentals.
If you were to target gains so large that inflation, exchange rates and central bank shenanigans becomes irrelevant… then they become less relevant.
But where can you find such opportunities? Here…
Nick Hubble
Editor, Fortune & Freedom
