If ever there were a land economic logic forgot, it’s Japan, a place where bitcoin mania is only trumped by demand for the world’s priciest government debt.
Tokyo’s relationship with the crypto boom is schizophrenic enough. The city has been covered in crime tape more times than bitcoin aficionados can count. Since 2014, it’s been the site of three of the biggest hacking heists ever–the Mt. Gox exchange in 2014, Coincheck in 2018 and Bitpoint in July.
Despite that, epic volatility in cryptocurrency values and the market’s penchant for bubbles, Japan is working full speed ahead perfecting rules and regulatory guardrails to ride the blockchain revolution. Whatever comes of the crypto game, Tokyo intends to be a mecca for digital currency trading and initial coin offerings.
Looked at another way, Tokyo may be the ideal experimentation ground given the funhouse mirror nature of its own financial system. Exhibit A: a government bond market that long ago lost touch with any semblance of reality.
Many punters have marveled at bitcoin’s emergence as an unlikely safe haven in times of turmoil this year. Boosters don’t call its “digital gold” for nothing. It follows, though, that Japanese government bonds are playing an “analog gold” role in global markets that belie the laws of financial gravity.
Yields on Tokyo’s 10-year debt are -0.27%, compared to 1.72% in Singapore, 1.53% in the U.S. and 1.32% in South Korea. It’s remarkable, though, considering Japan’s rising debt, dismal demographics and, arguably, darkening economic trajectory.
For all the handwringing over America’s debt surge under Donald Trump, Tokyo’s burden is markedly worse: more than double Japan’s $5 trillion worth of annual output. Add in stubborn vestiges of deflationary pressures and a rapidly aging population, and one has myriad reasons to wonder how Japan can ever repay its IOUs. And, oh how, the Ministry of Finance keeps the world’s most obvious asset bubble from imploding.
It helps when the Bank of Japan hoards more than half all outstanding government securities, as the central bank has done since 2013. Demand for JGBs, as traders call them, has also come from Japan Inc. For generations, JGBs have been the main financial asset held by banks of all sizes, pensions, insurance companies, local governments, the postal system, universities, endowments, the gamut of companies and retirees.
Yet JGBs, like bitcoin, have become an unlikely haven from the global financial storm. Cryptocurrency prices, for example, have generally been negatively correlated with the yuan. When the Chinese exchange rate slides, spooking world markets and trolling U.S. President Trump, bitcoin tends to rally, and vice versa.
Japanese government debt, too, tends to get a bid when Trump ratchets up his trade and Chinese President Xi Jinping retaliates. One can argue the yen wins what might be seen as a financial beauty contest. Through the lens of a global economy in unprecedented disarray, Japan’s political reality is the least ugly in investors’ eyes.
Who’d touch the euro or pound as Boris Johnson puts the finishing touches on pulling Britain out of the European Union? There aren’t enough Swiss francs in circulation to rush there. The yuan is an opaque, minimally convertible currency backed by a Communist government-controlled central bank. The dollar, meantime, is protected by a Federal Reserve under daily attack from an erratic president on a debt-issuing tear.
So, perhaps by pure default, the yen looks fine. But the epic debt that a shrinking population must service raises uncomfortable questions about negative yields. JGB holders, remember, are effectively paying Japan for the honor of holding its debt.
There’s a certain logic to why Japanese interests do it. The fact that virtually every entity in the nation would be hurt by rising yields creates overriding incentives to keep them stable. Think of it as mutually assured financial destruction.
Yet this arrangement also ensures that the BOJ’s historic easing won’t restore Japan to its 1980s economic greatness. That requires bold reforms of the kind Prime Minister Shinzo Abe has been promising since 2012. Sadly, his big talk of reanimating Japan’s innovative spirits, kicking off a startup boom and boosting wages gave way to complacency. Abe outsourced reflation efforts to central bankers ill-equipped to remake the economy.
In fact, two of the top upgrades on Abe’s watch are actually weighing on inflation. One, the giant trade deals onto which Abe signed–the Trans-Pacific Partnership and a major pact with the EU. Two, a drop of as much as 40% in monthly mobile phone bills enacted in May. Both moves are aimed at raising efficiency and competitiveness. Yet both place downward pressure on consumer prices. At the moment, they’re rising at a 0.6% rate, less than halfway to the 2% target.
On Oct. 1, Abe’s government is set to make an economic own goal by raising sales taxes. You don’t need to Google “Herbert Hoover” to understand the folly of tightening fiscal policy in a disinflationary environment. Officials forget what happened in 2014, when the economy slid into a modest recession after Tokyo hiked consumption taxes to 8% from 5%. Bumping them to 10% as trade war headwinds intensify smacks of economic suicide.
Ostensibly, Abe’s Liberal Democratic Party is raising taxes to pay down debt. Yet its debt rose at least 3 percentage points from 2014, the year before the last bump, to the end of 2018. Odds are, 24 months from now, Tokyo will have even more debt to service with even less growth and fewer people.
In 2018, after all, government debt hit a record high above $10 trillion while the population shrank by a record amount. Any objective assessment must leave one nervous about the impossibly low level of JGB yields.
Not as nervous, perhaps, as cryptocurrency holders watching values yo-yo from months to month. But any change in investors’ confidence in Japan’s ability to keep rates low would shake markets already on edge. The end of crypto mania would be a source of fascination for governments. The end of JGB mania would have world leaders everywhere at battle stations.