Almost 100 years ago a children’s tale known as “The Spider’s Thread” (Kumo no ito) described Buddha’s compassion for a criminal named Kandata. It sums up the problems facing the Bank of Japan and how it intends to climb out of fiscal hell.
Buddha is meandering around Paradise one morning, when he stops at a lotus-filled pond. Between the lilies, he can see, through the crystal-clear waters, the depths of Hell. He notices one sinner in particular – Kandata. Kandata was a cold-hearted criminal, but had one good deed to his name: while walking through the forest one day, he decided not to kill a spider he was about to crush with his foot. Moved by this single act of compassion, the Buddha takes the silvery thread of a spider in Paradise and lowers it down into Hell.
Down in Hell, the myriad sinners are struggling in the Pool of Blood. Kandata, looking up by chance at the sky above the pool, sees the spider’s thread descending towards him and grabs hold with all the might of a seasoned criminal. The climb from Hell to Paradise is not a short one, however, and Kandata quickly tires. Dangling from the middle of the rope, he glances downward, and sees how far he has come. Realizing that he may actually escape from Hell, he is overcome by joy and laughs giddily. His elation is short-lived, however, as he realizes that others have started climbing the thread behind him, stretching down into the murky depths below. Fearing that the thread will break from the weight of the others, he shouts that the spider’s thread is his and his alone. It is at this moment that the thread breaks, and he and all the other sinners are cast back down into the Pool of Blood. In the end, Kandata condemned himself by being concerned only with his own salvation and not that of others.
Bernanke was in Japan warning advisors to PM Abe that Japan risked slipping back into deflation (err it is already in deflation). He noted that helicopter money — in which the government issues non-marketable perpetual bonds that are linked to O/N rates plus a premium with no maturity date and the Bank of Japan (BoJ) directly buys them — could work as the strongest tool to overcome deflation. The government would hold the right to redeem the perpetual bonds at their face value. It would only logically choose to redeem if inflation came back in the mix.
In essence the BoJ has bought 40% of outstanding JGBs ($4 trillion) and the balance is held mostly by domestic financial institutions. If they end up swallowing all the $10 trillion of outstanding JGBs the idea is that they are packaged as a swap into perpetuals. The Diet would have to ratify this transaction and the complexity of it would likely bamboozle most Japanese politicians. I’m not quite sure if that makes it an easier or harder sell. The BoJ’s balance sheet is as big as the US Fed
None-the-less, if you park a majority of the $10 trillion dollars (Y1,000 trillion) or 2x GDP then it doesn’t overcome the need for the government to raise Y40-50 trillion (or raise a Switzerland) annually to cover the shortfall in the budget deficit given the dwindling tax base. This gap is ongoing.
While $10 trillion dollars can be put inside a velvet bag and packaged in a way that disguises the contents then it come down to how willing financial institutions will step up to buy new JGB issuance. The risk is that if the BoJ is the only willing buyer them the psychological impacts on the lack of confidence of buying JGBs any collapse in the currency will potentially create inflation that will be far harder to control. Japan imports 60% of its food and most of its raw materials and energy. To all of a sudden be faced with dollar denominated contracts to mitigate risk for suppliers Japan’s inflation could soar way beyond desirable levels. Would a yen fall to Y300 or Y400/$ from almost parity today? Then we are staring down the barrel of double digit rate inflation.
Let’s consider the collapse of the Argentinian Peso in early 2000s. It exploded from 1/US$ to 4/US$ and today trades closer to 14.5/$. At the time inflation surged to 25% and has remained between 5% and 20% since.
As soon as markets have seen the MoF & BoJ in cahoots on monetising the debt, the risk is that they can always do it again. No-one ever suspected they would do it in the first place but once it is done it can be done again and Japan is 10x the size of Argentina so the knock on effects are far greater.
Imagine even 10% rates of inflation in Japan. Banks that have loan books that are 30 years fixed at 3% and below with 90%+ of financing coming from deposits. If the currency was collapsing, Mrs Watanabe would be flocking to safe havens – gold, US$ etc. If there was a run on the banks, deposit rates would have to go high enough to offset the flight. At the same time, the net margins would be crucially negative causing the likelihood of nationalisation with yet more printed money…exacerbating the problem.
Which takes us back to Kandata. The financial gods may lower a spider’s thread but if central banks become too greedy in implementing helicopter strategies, it will snap as they climb from the infernal hell they’ve traded themselves into. Then it really will be a pool of blood.
I also think listening to Bernanke is not necessarily wise as he merely continued in the footsteps of Greenspan to lead us into the GFC. Should we credit those who got us into this mess with pretending they’ve got us out of it? To me, the failing experimentation in financial markets is disproving a lot of theories of monetary policy (especially NIRP) and the declining confidence in central banks expressed by rising poverty is being shown in the shake up of incumbent political classes. It feels that the big RESET button will have to be pushed.