They Keep Assuring Us Japan Can't Happen Here
AP Photo/Karel Navarro, File
They Keep Assuring Us Japan Can't Happen Here
AP Photo/Karel Navarro, File
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He actually meant it to be soothing, a reassuring statement of clear and unequivocal support for a reeling market. This statement, however, was received in the exact opposite way. The selling which had gone on seemingly unchecked for weeks was suddenly and materially amplified. The government was no longer going to be buying, but this was no big deal?

It wasn’t actually the government, though, and its official statement issued through the Finance Minister really was ambiguous – at best. This was December 1998 in Japan. After nearly a decade of the worst, most insipid form of economic disease(s) here was yet another one for officials to confront, yet another opportunity for them to screw it up.

Kiichi Miyazawa had already been the Japanese Prime Minister in 1992 and much of 1993, some of the worst parts of the bubble collapse and its immediate aftermath. Having suffered what initially appeared to be a heavy but typical downturn, it was clear by mid-decade the country’s economy was wedged underneath something very different.

Fiscally cautious by nature, successive Japanese governments had approached the ideas in the Keynesian textbook with equally as much skepticism as reverence; especially when it came to the government’s credit. Even when dutifully acceding to the textbook need for spending under the name “automatic stabilizers”, or when piling onto them with an almost regular schedule of supplementary budgets, the tilt toward care had been thrown out the window by the end of ’97.

You could at least understand why they’d end up with a radical departure; after suffering a huge wipeout and economic downshift to start the nineties, there hadn’t been a recovery yet and the nation didn’t really see many prospects for a legitimate one until the closing months of 1996. And even then, it was arguable; recoveries, when they are true recoveries, aren’t controversial.

Convinced otherwise (convincing themselves otherwise), the Japanese government recommitted to fiscal responsibility believing that, though it took more time than initially thought, economic salvation had been fairly won. A tax hike and end to other favorable credits was scheduled for ’97 – right into the teeth of what later became known as the Asian Financial Crisis (or Asian “flu”, since the fundamental dollar disease at its core proved to be contagious).

There are times when you do something you aren’t sure about, and then immediately come to regret not listening to your doubts. That was Japan at its 1997 tax hike(s). By the start of the next year, any lingering objections to fiscal profligacy no matter how well-reasoned and well-established were thrown right out the window.

In April 1998, a massive “rescue” package was announced, totaling ¥16.7 trillion. Though the net contribution of government spending and tax cuts was significantly less than the headline number, it was substantial and represented a sweeping increase and departure nonetheless.

But as shocked as anyone might have been at this first one, a second, even larger package would be put forward that same November. Jumping up to ¥23.9 trillion, the Japanese people had begun to believe their government had collectively lost its mind.  

Among them, there were those who had invested heavily in the Japanese government bond (JGB) market wondering if it was even worse than that. Who would be left standing to buy all those bonds the central authority would have to issue in order to finance such massive deficits? Whereas JGB prices had relentlessly increased for years as the “lost decade” depression only deepened, and the same market which had totally and completely discounted the ’97 recovery prediction, suddenly in late ’98 there was a palpable sense of basic economics.

On November 16, Prime Minister Keizō Obuchi, who had only been in office for a few months, having replaced Ryutaro Hashimoto whose first big “stimulus” package hadn’t arrested the economy’s slide, announced this much bigger second program. The following day, analysts (and their models) from Moody’s downgraded JGB debt from Aaa to Aa1.

The bond rout was on.

The yield on Japan’s 10-year JGB had been as low as 77.2 bps early in October ’98. As the government debate progressed, the indicated rate would back up as high as 96.5 bps and was trading 91 bps on the 16th when the government announcement came. The initial downgrade hadn’t triggered the bond selling initially, but combined with a global recovery gaining steam and what that might mean for Japan (inflation and risk-wise), by the end of the month yields were off to the races (higher).

And then Miyazawa.

As Finance Minister, the guy was also the head of something called the Trust Fund Bureau (TFB). A quasi-government agency, this entity took in deposits from Japan’s Pension fund reserves and more importantly more deposits from the Postal Savings system (the Japanese people had historically deposited and held the majority of their savings with the Japanese equivalent of the Post Office). Along with borrowed cash received from the Postal Life Insurance Fund, this TFB had sat in the middle of a complicated, dizzying array of financial tentacles stretching through numerous parts of the real economy as well as government.

It was something like a GSE, or at least one-half of what we might think of when examining Fannie or Freddie. The TFB was the fund-raising arm of a quasi-superbank structure not held together under one roof. The other part, the disbursements, went to local governments as well as the central government’s General Account. In both of those cases, the TFB bought bonds issued by each.

This meant that the TFB was a big buyer of JGB’s. But with Japan suffering a serious downturn in ‘98, nearly every participant on the other end of those tentacles had their hand out looking for rescue.

Miyazawa realized that TFB’s ability to buy more JGB’s was going to have to be pushed way down on the list of disbursement priorities; a policy change which he announced on December 22.

But, as I started out, the Finance Minister thought he was being a reassuring presence. What he said was, “the suspension of government bond purchases by the Trust Fund Bureau is not a particularly serious matter.” The JGB market, initially, disagreed believing that any tapering of purchases by such a pivotal financing arm in the face of a huge increase in supply could do more than upset such a highly-priced government bond market (pop this “bond bubble”, as so many have called it).

The selling which had been widespread and harsh to that point grew more widespread and even more harsh in what came to be known (to the few who followed or still follow the history of JGBs and Japan) as the Trust Fund Bureau Shock. Whereas the 10-year JGB yield had surged to 1.47% in the days before this, in just three sessions it would spike nearly 50 bps more to 1.982% by December 24, 1998.

To end such a tumultuous year, the 10s would achieve 2.117% and ultimately 2.43% by February 5, 1999. The last thing Japanese authorities had wanted was sharply rising interest rates.

Despite the introduction of so much fiscal “stimulus”, the outcome it might lead to was far from assured. In fact, the Bank of Japan, who you’d think would have been the Finance Ministry’s best friend in all this, remained highly skeptical of its potential effectiveness (and why not, having witnessed several packages roll out over the years with little positive impact even if they hadn’t been quite so large?)

In its regular Monthly Report for December 1998, the Bank of Japan wrote:

“With the implementation of the government’s comprehensive economic stimulus package and recently launched emergency economic measures, the economy is likely to be underpinned mainly by public investment toward the first half of fiscal 1999. Furthermore, the Bank’s monetary and financial measures and the government’s measures to alleviate the credit crunch are expected to take effect gradually. Nevertheless, an immediate self-sustained recovery in private demand is hardly expected since corporate profits and household income are deteriorating and the constraints from corporate finance are likely to persist for some time due to cautious lending attitudes of private banks.”

Not only would this prove to be true, in February 1999 the BoJ voted to begin the world’s first experiment with a zero interest rate policy, or ZIRP. The situation came to be dire as demonstrated by a seriously negative GDP rate for Q1 ’99 (-1.2%, q/q at a quarterly rate). The government may have done big things in ’98, but these hadn’t created a recovery, either.

Instead, “attitudes of private banks” prevailed; as these always had prevailed before (in 90s Japan) and have continued to prevail ever since (not just in Japan nor just in the nineties).

So, what to do when the banking system won’t step aside even in the face of the biggest “stimulus” programs? Common sense dictates fixing the banking problem – which the Japanese were busy doing, or thought they were doing, using bank reform and recapitalization projects – but Economists have other ideas.

It might also seem logical that if the banking system continues to be the single most significant impediment (clogged transmission channel) to recovery that you instead find ways to simply circumvent it. On the surface, it makes perfect sense; banks get in the way, then go around them by using the central bank or central government, or central bank financing the central government, to put cash directly in the hands of businesses and people.

While this might sound a relatively new theory, a radical departure put forward only in the last days of, say, December 2020 around this side of the Pacific, this is nothing new. In fact, neo-Keynesian Economists like Ben Bernanke have been discussing the theoretical merits of what they called “money-financed fiscal expansion” for a very long time.

And a lot of that discussion took place because of what really happened in Japan (what wasn’t supposed to have happened). Here’s what Bernanke wrote in 2003:

“Isn’t it irresponsible to recommend a tax cut, given the poor state of Japanese public finances? To the contrary, from a fiscal perspective, the policy would almost certainly be stabilizing, in the sense of reducing the debt-to-GDP ratio. The BOJ’s purchases would leave the nominal quantity of debt in the hands of the public unchanged, while nominal GDP would rise owing to increased nominal spending. Indeed, nothing would help reduce Japan’s fiscal woes more than healthy growth in nominal GDP and hence in tax revenues.”

This materially differed from the typical bond-financed fiscal expansion which had, they thought, triggered the bond rout leading up and past the Trust Fund Bureau Shock of ’98. If the government needs to increase spending and aid because “aggregate demand” has declined substantially, the last thing it needs is the bond market opposing that “necessary” expansion by worrying about too much bond supply.

Instead, along comes the central bank to – in the short run – finance (not “monetize”; they’re careful to point out how they believe there’s a difference) this expansion so as not to upset the bond market’s potential to absorb the burst of new bonds which have to be issued.

By undertaking money-financed fiscal expansion, proponents claim, they get around the banking system’s clogging and inject the government money directly into the real economy in sufficient measure. As this is expected to lead to full recovery, those rising economic fortunes quite necessarily create much higher tax revenues (bringing the fiscal situation back in line) and then inflation – which in the future requires the central bank to sell those JGB’s it previously had bought back out to the public.

Neat, clean, easy; it's practically self-extinguishing – if it was ever to work flawlessly in such a way.

You see, the Trust Fund Bureau didn’t just buy up JGB’s thereby funding the central government being a middleman between postal savings and the government’s deficits. One other significant recipient of its accumulated financial heft was something called the Fiscal Investment and Loan Program (FILP).

In fact, one of the reasons why Kiichi Miyazawa’s Finance Ministry had planned to reduce their JGB purchases in late ‘98 was because officials knew they’d need to send more to the FILP.

What was the FILP? Though its roots date back to 1953, it was essentially an off-the-books mechanism by which the government could implement desired real economy projects. Whether finance public works or the like directly, or to lend and grant to private companies, the FILP was pretty much the thing Economists had in mind which could and quite often did circumvent the banking system to directly inject an increased fiscal expansion directly into the economy.

And its footprint had grown enormously throughout Japan’s “lost decade.” The FILP had even come to be known as the “second budget”; referring to the central government’s ability to use the thing, and as many as 38 related special accounts, agencies, and public corporations, to direct off-the-books spending and aid all financed by this quasi-public banking.

It was estimated that by 1999 these opaque, largely unaccounted activities of the FILP had equaled around 70% of the government spending on the books in the general budget accounting. It’s not like the Japanese hadn’t tried.

But, as that economy settled right back into its same rut in early ’99, confirmed by the Bank of Japan’s panicky imposition of ZIRP at that same time, JGB bond yields went right back down again. And in the more than two decades since, they have yet to get back to as high as February 1999; the 10s once nearly touched 2%, for a brief time, in 2006.

What Ben Bernanke had also said in November 2002 goes here. Having discussed and mythologized the Fed’s printing press, and all its possible uses – including money-financed fiscal expansion – what he said was, very simply:

“We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

He and those like him, including Jay Powell as well as Janet Yellen, presumably believe that even today. What Japan has established, and has really proved, is that, no, even a “determined government” may encounter deflationary, depressionary forces beyond its ability to manage (or understand). Furthermore, these can last a very, very long time (which the trio Bernanke, Yellen, and Powell should know already from personal experience). Worse, repeated failure can even contribute to the stubbornness by which these persist.

Economists, of course, will object to these characterizations; typically, they claim that given the chance, as Powell and Yellen together will presumably be given in the upcoming months if not weeks, they won’t repeat the Japanese mistakes. If Japan failed at any of these things, it’s because, they say, the Japanese – specifically - failed.

Sound theory, bad execution. Not for nothing, they said the same things about QE.

In terms of money-financed fiscal expansion, you can easily predict the criticisms – not “enough”; or, not the “right” sort. Our people will figure out the “correct” way to get it done.

What if the problem isn’t the Japanese version, what if the theory is just wrong? How might we know?

Seems to me there is a lesson here in JGB’s. For a few months, anyway, what turned out to be a minor hiccup, this Trust Fund Bureau Shock, it was simply the first look at a potential unknown. But, the JGB market for more than two decades since, now the theory, and its potential, these happen to be very well known.

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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