The Economist Middle East and Africa Edition - 24 August 2019

60 Finance & economics The EconomistAugust 24th 2019

2

Buttonwood The eternal moment

I

n the 1920sE.M. Forster, an English

novelist, set out the difference between

a story and a plot. “The king died and

then the queen died” is a story, he wrote.

But a sense of causality is needed to

make a plot more than just a sequence of

events. “The king died and then the

queen died of grief” is a plot.

Investors like stories as much as

anyone. They like plots even more. A

durable narrative, and one that is on

everybody’s lips once again, is “Japan-

ification”. A Forsterian summary might

read: “The bubble burst, people became

cautious and the economy got stuck in

too low a gear to stop prices and interest

rates from falling.” In its strongest form

Japanification is a pure tragedy, in which

rich, debt-ridden economies are des-

tined to follow the path set by Japan. In

another, softer version only countries

with rapidly ageing workforces, such as

Germany, are thus fated.

Germany’s bond market is now priced

for endless stagnation. Its interest rates

are negative on everything from over-

night deposits to 30-year bonds. But it is

striking how depressed bond yields are

in countries with only a passing re-

semblance to Japan. A 30-year American

Treasury yields just 2%, for instance. As

currently scripted, Japanification is

narrowly defined but broadly applied. It

is the fear that policymakers have lost for

good their ability to gin up the economy.

A big question is whether the current

situation is just one act in an unfolding

drama, or where the story ends.

Japan’s experience was the trailer for

all this. When its ten-year bond yields

fell below 2% in 1998, there was a lot of

head-scratching, says Peter Tasker, a

seasoned analyst of Japan’s economy. At

the time, Japan’s government had a huge

budget deficit. For its long-term interest

rates to fall made little sense. Hedge funds

began to short Japanese government

bonds (a lossmaking trade that became

known as the “widowmaker”). But the

country’s consumer prices kept drifting

lower. And so did its interest rates.

Ever since, Japanification has been a

fear that is alternately raised and dis-

missed. In November 2002 Ben Bernanke,

then a governor of the Federal Reserve,

gave a famous it-can’t-happen-here

speech about Japan. The lessons drawn

from Japan’s failures were: own up to bad

debts; fix the banks; use policy tools to

spur the economy; don’t let asset prices

collapse. After the 2008 crisis, some of

these lessons were applied, if unevenly. A

decade on, Japanification is back. People

continue to be astonished by how far

long-term interest rates can fall, just as

they were earlier in Japan. And the de-

clines have been broadly felt. In Australia,

which has a young population and has not

suffered a recession in a quarter-century,

ten-year bond yields are below 1%.

The cause of all this is renewed concern

about global stagnation. A synchronised

pickup in the world economy in 2017 has

turned to synchronised slowdown.

Central banks, including the Fed, are

cutting interest rates. But there is more

to it than that. With short-term interest

rates already so low, there are grave

doubts that central banks have the power

to get the economy back on track. You see

this pessimism in forecasts of medium-

term inflation derived from the swaps

market, which are markedly lower than

they were earlier this year. “The problem

with being Japan is that if you get an

economic shock, monetary policy has

nowhere to go,” says Steve Englander of

Standard Chartered, a bank. Europe has

already reached this point.

There is an alternative script. In this

version today’s Japanification spurs a

response that leads to its defeat. If mone-

tary policy has run out of road, there is

always fiscal policy. If the economy lacks

demand, governments can help to fill it

by borrowing cheaply to cut taxes and

raise spending. The politics are not there

yet, but the Japanification of bond mar-

kets will move things along. “Before

there is a consensus on a shift in policy,

you need to see the downside risks [to

the economy] clearly,” says Mr Eng-

lander. Once that shift takes place, the

fear of stagnation recedes.

The political response to the threat of

stagnation is likely to be more radical

than it was in Japan, says Mr Tasker. The

tricky part for bond investors is guessing

how long this takes. There are already

stirrings of a rethink in Germany, a coun-

try hostile to fiscal stimulus. For now,

these are only stirrings. Bond yields may

languish for a while, before they rise in

anticipation of fiscal stimulus. But the

queen need not die of grief. After a period

of mourning, she may find happiness

again. The plot thickens.

Is the Japanification of bond markets a passing phase or permanent state?

climbed from an average of less than 1% last

year to more than 4% this year (see chart on

previous page). Officials say the lprwill

lessen the strain on companies. On August

20th, the day it went into effect, the rate

was set a tenth of a percentage point below

the previous benchmark, a marginal cut.

Nevertheless, it would be a mistake to

view the lpras a silver bullet, either for

monetary easing or for China’s longer-term

project of interest-rate reform. When

banks are concerned about the economic

outlook, as many increasingly are, they can

simply demand higher risk premiums over

the benchmark from their borrowers.

There is no getting round the fact that

China must do more if it wants to embold-

en its lenders. The central bank would need

to cut their funding costs sharply, but it is

reluctant to do so, worried about whipping

investors into a speculative frenzy. The

government would need to expand its fis-

cal stimulus, but it is worried about adding

fuel to China’s debt problem.

As for the redesign of Chinese monetary

policy, there is still much to do. The central

bank formally answers to the State Coun-

cil. Any big changes in interest rates are

thus political decisions, not purely eco-

nomic ones (although a cynic might say the

same is true in America, Yi Gang, governor

of the People’s Bank of China, faces ump-

teen more constraints than Jerome Powell

of the Federal Reserve). Moreover, the lpr

makes China’s monetary-policy toolkit

more cluttered. Banks have been told that

for the time being the new benchmark will

not apply to mortgages. It will thus be pos-

sible for China to cut rates for companies

but not for homebuyers. After all these

years, Chinese planners remain reluctant

to cede too much power to the market. 7