The Stinky Japanese Bond
Central banks have been engaging in nontraditional, radical, and unprecedented policies in recent years. Policies such as zero interest rates, quantitative easing, a war on cash, and even negative interest rates on bank deposits are now the norm. There has even been talk of helicopter money. This is not money falling out of the sky for you and me. It means central banks simply print money and give it to the government. The latest installment of monetary insanity comes from Japan where the new monetary policy will target the 10-year Japanese government bond at 0% interest rate.
The Bank of Japan, like the European Central Bank and the Federal Reserve, have all been buying government bonds in order to keep the cost of financing national debt low. They claim to be stimulating the economy, but that has not worked and is probably not their real intention. Thus far, it has worked to keep the interest rates on government bonds very low even in Italy, while pushing rates negative in Switzerland and Germany!
Japan’s policy of zero interest rates on government bonds means that you lend Japan $10,000 and 10 years later they return your money to you. Sounds like quite a deal for the Japanese government, but a stinky deal for bond buyers. What does this policy mean for the economy in general?
First, it’s a risky policy even by mainstream economic standards. It has been long thought that central banks cannot control long-term interest rates and should only target short-term interest rates. The Bank of Japan is already buying around $800 billion of Japanese government bonds per year. Trying to stabilize the rate on 10-year bonds at a zero interest rate could result in the Bank of Japan being forced to buy unlimited amounts of long-term government bonds. The BOJ has also an enormous portfolio of Japanese stocks, purchased to stimulate the Japanese stock policy. That experiment in monetary policy has also failed.
All this folly with monetary policy by central bankers has not produced the promised beneficial effects. This tells us two things about modern central bankers. First, they do not really understand monetary policy and interest rates and their effects on the economy. Second, their policies are directly benefiting the governments that they work for, big banks, and crony capitalists.
What they have been doing is known as the concept of “financial repression.” The idea behind financial repression is to repress the private productive economy with ultra low interest rates. This allows for the stealthy stealing of resources from the economy and to reallocate those resources to governments and crony capitalists. The reduction of interest rates hurts the private productive sectors and benefits governments and big crony capitalists by lowering their borrowing costs.
The losers from financial repression include some of the most important groups in a capitalist system.
Labor is a big loser. Real medium household incomes in the US have been declining or stagnant for over 15 years. It has been known for ages that monetary inflation and low interest rates help capital and harm labor as wage rate increases tend to lag inflation.
Savers are an obvious big loser from the artificially low interest rates. The interest rate on my savings account is 1/100 of 1%. Given that there is price inflation, this means I am losing money on my savings. Central bankers have long claimed that they are not trying to stimulate stock markets, but the negative returns from savings have forced savers and retirees to invest heavily and imprudently in highly risky stock markets.
Another thing that central bankers don’t know is that real actual savings have to take place in order for real capital investments to take place. Capital investment increases labor productivity and economic growth. Central bankers are otherwise clueless as to the slowdown in recent years of labor productivity. They think that real savings can be easily replaced by their monetary manipulations.
Insurance companies are critical in any free capitalist economy. We purchase insurance to protect our homes, our cars, our health, and our lives. The insurance premiums we pay to protect these items are invested by insurance companies in order to pay the claims that we make in the future. That is a very difficult task in a zero or negative interest rate environment. Insurance companies would like to invest in relatively low risk assets, but have now been forced to take on riskier investments in recent years to be able to guarantee that claims will be paid.
Pension funds are also very important. Millions of Americans invest in pension funds of various sorts in order to finance a decent retirement. Like insurance companies they have been put in a difficult situation by zero and negative interest rate policies. In their search for a return on their investments they have unwittingly placed their clients’ money in risky assets. Even with that added risk, state employee pension plans are now only 70% funded on average.
So there you have it. Workers, savers, insurance companies, and pension funds are harmed by these radical monetary policies. In other words, the productive classes and the institutions which are the foundations of capitalism are harmed. And at the same time governments and crony capitalists are living high on the hog.
There is another professional phrase used by mainstream economists to describe this quagmire of monetary policies. It’s called “macroprudential” policy. This involves several policies none of which makes economic sense individually, but when viewed from a general mainstream economic perspective does make good sense. So for example, a zero interest rate policy does not make any economic sense. Also, unsustainable government budget deficits and national debt does not make economic sense. However, the combination of two irrational policies is said to be a good “macroprudential” policy.
Of course the real and obvious prudent policy would be to allow markets to set interest rates and for government budgets to be balanced at a lower, sustainable level.
The latest stinky deal coming out of Japan tells us that central bankers have not learned this economic lesson, and to expect more monetary folly in the future.
Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows. Contact: email, twitter, facebook.