The Bank of Japan continues to go where no central bank has gone before.
We’re talking “Let’s make it up” territory.
The basic problem is that the Bank of Japan’s massive buying of government debt has failed to either raise the inflation rate in Japan’s economy or to stimulate much in the way of economic growth. But even the Japanese bond market doesn’t have an endless supply of government debt.
So the Bank of Japan has been forced into buying other assets in an effort to stimulate the economy in the hope of avoiding so distorting the financial markets that it leads to a bubble/collapse/whatever.
The Bank of Japan is buying about twice as much debt as the Japanese government is issuing, even with the deep budget deficits that the government is running.
As of September 2016 the Bank of Japan owned about one-third of all Japanese government debt. And the bank is on a path to own 60% of government debt by the end of 2018.
Subtract the Japanese government debt held by Japanese banks as collateral at the Bank of Japan and by the end of 2018, the Bank of Japan could be the market for Japanese government debt.
That’s a position the Bank of Japan would certainly like to avoid. Which has led the Bank of Japan to monetize some very strange assets.
For example, the bank has pledged to buy 6 trillion yen ($51 billion) a year in exchange traded funds. Last summer that led Japan’s creative investment banks to create a wave of new ETFs that nobody in the market really wanted but that could be sold to the Bank of Japan.
That was last summer.
Now it’s REITs. The target is much smaller–90 billion yen ($0.8 billion) in purchases, but the market is also much smaller, especially given credit rating restrictions on the REITs that the bank can buy.
All this looks like a delaying action before the Bank of Japan has to either become the government bond market–and thus effectively monetizes Japan’s huge and rising government debt–or admit that the basic premise of current monetary policy is completely wrong and that the country can’t purchase itself out of its current economic problems.
Implications for the global financial markets are crazy dangerous. Right now the markets are treating the yen as a global safe haven asset. How long can that continue given the trend in the Japanese bond market? Interest rates in Japan are either negative (-0.17% on the two-year government note) or essentially zero (0.05% on the ten-year government note.) Is it possible to sustain that level of yield as the Bank of Japan moves toward owning the bond market? Will bond investors want to buy Japanese government debt in a market composed of the Bank of Japan and nobody else?
The Bank of Japan might not be out alone in this wilderness for long. The European Central Bank faces similar problems with a lack of assets to purchase for its goal of buying 70 billion euros a month. Will the European Central Bank join the Bank of Japan in heading down this road or will the Japanese experience wave a caution flag at Frankfurt? (Add in the possibility that the weak euro is about to cause the German economy to show signs of overheating and monetary policy at the European Central Bank is likely to become disputed ground in 2017.)