60 Finance & economics The EconomistAugust 24th 2019
2Buttonwood 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 interestrates 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 synchronisedpickup 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 overthe 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 arethus 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