It has been 23 years since the Nikkei began to collapse and 19 years since we saw signs of deflation in Japan. Now, the Japanese government is finally preparing to aggressively target stimulating its country's economic activity by implementing massive monetary depreciation and directly monetizatizing new Japanese sovereign debt.
If the government succeeds in pursuing this path, the impact this will have on global capital markets is extraordinarily difficult to anticipate.
One of the primary reasons economists cite for the ineffectiveness of the fiscal and monetary interventions Japan has pursued over the past 20 years to successfully cause an increase in domestic economic activity there is that it has been too timid and with each stimulus measure. The government and central bank have been too far behind the demographic drag Japan has been experiencing for their actions to achieve their goals.
In the past few months, even as the Japanese have increasingly indicated their intentions to embark on this strategy, I have thought it was more political rhetoric than real strategy. Theoretically, this process would require the Japanese government to attempt to directly manage the value of the yen vs. other currencies, especially the U.S. dollar and euro. Part of that process would require the Bank of Japan not only to directly monetize new Japanese sovereign debt but to also purchase and attempt to manipulate down the long-end sovereign yields in the U.S. and Europe.
This is akin to the Japanese government attempting to exert control over not only the Japanese economy and Bank of Japan, but over much of the global capital markets.
At this point, we don't know if they will really make the attempt, how large the intervention will be, or what the response to it by global private capital and monetary, fiscal and government authorities in the rest of the world will be. But if they do begin this process, it should cause 10-year sovereign yields in the U.S., Germany and Japan to begin to move toward convergence. The dominant question is whether that means Japanese yields will rise to meet German and U.S. yields or if the German and U.S. yields will decline toward the Japanese yields.
The 10-year yield in Japan is about 80 basis points right now. The German yield is 1.43 and the U.S. 1.85%. All have risen over the past month, but the U.S. yields have risen the most.
Private sector Japanese investors appear to be unwinding their carry trades from first-tier global sovereign debt in the U.S., Germany, and the U.K., and recirculating the proceeds into Japanese equities. Meanwhile, concerns about a depreciating yen and the negative impact on real returns to Japanese investors take precedence to nominal returns achieved by investing outside of Japan.
This is helping to propel global equity prices higher, but it is also putting upward pressure on global long-end sovereign bond yields. The 10-year sovereign yields in the U.S., Germany, the U.K., Australia, and Japan have all been rising over the past month.
If the Japanese government successfully institutes these yen depreciation and management policies, long-end global sovereign yields will likely begin to decline soon afterwards because public money will soak up first-tier sovereign debt and force private capital increasingly into global equities, corporate bonds, real estate, gold, other hard assets, Japanese equities, and sovereign debt of second tier countries, such as Brazil.