Taps Coogan – July 31st, 2023

Kevin Heber, Managing Director at Epoch Investment Partners and former researcher at the Bank of Japan (BoJ), recently spoke to CNBC about the significance of the BoJ significantly widening the range on its Yield Curve Control (YCC) program. That policy change sees the BoJ’s limit on the 10-year yield raised from 0.5% to 1%.

While Mr. Heber calls the BoJ’s ultra accommodative policy warranted in the mid-and-late 1990s, he says it has been a mistake for the last 20 years.

 

Kevin Heber:

“I think the type of policy they’ve had in place… made sense in the mid 1990s and late 1990s… I think it’s been an inappropriate policy for the last 20 years. Japan hasn’t had the same cyclical issues and when you have zero interest rates it creates all sorts of distortions and dislocations that I think are very harmful and the sooner that they can move to a more normal structure, and let bond markets and equity markets do the sort of work they need to do, the better. Uedo… certainly knows this but he also knows that the transition has to be reasonably slow to allow households and corporates time to adjust to the normal…”

“We’ve had lots of trade over the last 25 years or so where it looked like Japan was doing the things it needed to do (to normalize policy) and companies were starting to focus on return on equity, return on invest capital, share holder returns, …equity markets went up, but then it petered out… So right now there are a lot of signs that things are improving but I think it’s important to be skeptical…”

While the idea that Japan has finally turned the corner on ultra-accommodative policy is welcome, skepticism is indeed warranted.

Two things have driven Japan’s lost decades of near-zero growth and ultra-accommodative policy: a shrinking workforce & population and a massive debt bubble from the 1990s.

On the first point, Japan’s total fertility rate dropped to a record-tying low of just 1.26 in 2022, marking the seventh consecutive year where Japan’s already-low fertility rate has dropped further. Baring a radical change in immigration policy, further population declines are guaranteed for decades even if fertility rates increase because incoming generations are so much smaller than the generation currently exiting the fertility window.

On the second point, Japan’s total debt has increased radically since the 1990s as private sector debt was shifted onto the government’s balance sheet and then expanded upon by widening deficits.

The notion that a shrinking and aging Japanese population can support a perpetually increasing debt burden and the rising interest expense associated with a policy normalization is absurd.