There aren’t many precedents for the trauma that financial markets have suffered this week, as the coronavirus crisis drove U.S. stocks into a bear market and briefly sent yields on every Treasury bond crashing below 1%.
But there may be a precedent for the hole that policy makers find themselves in when the dust has settled. Just not an American one. The developed world’s last great holdout looks like it’s joining the Japanification club.
Amplifying the fear is the fact that central-bank interventions haven’t been able to turn things around like they used to. The plea arising from markets is for governments to step into the breach and use their spending power to shore up economies — in the short run. The Japanese lesson suggests that they might have to do it for quite a while.
“We’re essentially at the Japanese place,” former Treasury Secretary Larry Summers told Bloomberg Television on Thursday. “That’s a place that’s very hard to get out of.”
Conditions that don’t feature much in economics textbooks have been the norm in Japan for decades. Benchmark interest rates have been near zero or below, yet households and businesses still don’t want to borrow, leaving traditional monetary policy without traction. So the government steps in to finance what little growth there is with deficit spending.
Since 2008, most developed economies have looked at least a bit like that, and the growing damage inflicted by the coronavirus may be speeding up the convergence. Slow-growing Europe has already gotten used to negative borrowing costs. While the U.S. isn’t there yet, trend-lines are pointing in that direction — posing a challenge to Fed officials when they meet next week.
‘Heading That Way’
“If we define Japanification as the whole yield curve getting to zero, it does seem that the rest of the world is heading that way,” said Paul Sheard, a senior fellow at Harvard University’s Kennedy School. He was in Japan as an academic and financial-market economist in the 1990s and 2000s when its big shift was under way.
Japan-type conditions, exacerbated by the spread of the virus, are the latest test for central banks who are quickly running out of ammo. Soon they’ll have even less, according to traders who are betting that the average benchmark rate in developed economies will hit zero for the first time ever within three months.
Even if the central banks do act, it may not help much. When the Federal Reserve eased policy in an emergency move last week, it did little to reassure markets. Even Fed Chair Jerome Powell conceded that rate cuts can’t fix supply chains thrown into chaos by the coronavirus epidemic.
‘Lost the Plot’
Central banks have other options, like forward guidance to assure borrowers that now’s the time to take out credit, or the kind of lending programs for companies and support for banks that formed part of the European Central Bank’s crisis package announced on Thursday.
But markets were even more underwhelmed by the ECB than the Fed. It’s becoming clear that monetary authorities don’t have the policy room they did during the financial crisis, leaving the onus on governments.
“Central banks have lost the plot,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis and a former European Central Bank staffer. “Somebody else needs to step up.”
Japanese governments have been stepping up since the late 1990s, amassing a mountain of debt along the way. The virus threat is spurring yet more fiscal stimulus there, and across the globe.
If deflationary conditions settle in, many economists say the world is likely to see more dramatic steps by the politicians in charge of budgets -– perhaps teaming up with their central banks. The biggest oil crash in a generation, coupled with longer-term problems such as aging populations, support such expectations.
“From a big picture perspective,” Morgan Stanley economists wrote in a note Thursday, the virus shock “has once again brought the structural issues of debt, demographics and disinflation to the fore.”
Those are the challenges Japan has been grappling with for decades. They’re less acute in the U.S., which has a growing population and hasn’t seen headline inflation drop below zero since 2009. Still, producer prices tumbled last month in what may be an early sign of the virus’s impact.
In this deflationary environment, business and households have been reluctant to borrow, even after central banks slashed the cost of doing so. Governments could and did — and that’s why the dividing line between monetary and fiscal policy is getting blurred.
“Think of things like helicopter drops, think of things like fiscal deficits that could be partially directly monetised by central banks,” said David Mann, chief economist for Standard Chartered Plc in Singapore, on Bloomberg Television.
“These are the sorts of thing we now need to be actively thinking about,” he said. And this new toolkit will be needed “not just during this shock, but during the 2020s.”
“Helicopter money” usually describes the idea that central banks could print cash and deliver it straight to the public. Proponents call it a “break the glass in case of emergency” policy option.
Monetising deficits is something Japan is often charged with doing, though its policy makers stridently deny they’re doing so because the central bank buys bonds in the secondary market, not directly from the government.
The Bank of Japan has bought up close to half the national debt as part of its quest to keep government bond yields anchored and enable cheap borrowing. The low rates eases the burden for Japan to service its mountain of debt – and that’s gotten some Western economists thinking.
In his New York Times column last weekend, Nobel prizewinner Paul Krugman cited the Japanese experience to make an economic case for “permanent” fiscal stimulus in the U.S. -– while conceding that U.S. politicians aren’t likely to buy into the idea.
Krugman said the government should invest an extra 2% of GDP each year on things like infrastructure, child development and research — “and not pay for it.” Debt would rise, in his rough model, to around 200% of GDP before stabilising. “That’s terrible, right?” he wrote. “Um, why?”