The Bank of Japan is a profit-making institution. That could change. Takuji Okubo, chief economist at Japan Macro Advisors, expects the BOJ to start making losses this fiscal year because the BOJ’s own ultra-loose monetary policy has turned government bond yields negative.
Japan’s central bank is highly leveraged. Its balance sheet is less than 2% capitalized. Losses resulting from balance sheet stockpiles of negatively yielding debt would accumulate over time, should the pace of easing continue. “BOJ loss will eventually eat into capital. If they keep that up, Japan will have a central bank with net debt,” says Okubo.
While the BOJ can never go bankrupt—the government would backstop it—a technical insolvency could undermine market confidence. Recapitalization would drain government coffers, already saddled with the largest national debt of any advanced nation at 250% GDP. The central bank’s independence could be called into question. Worst case, global investors might decide recapitalization amounts to permanent monetization of national debt—’helicopter money’.
Japan’s central bank grew its share of the roughly ¥1,000tn Japanese government bond (JGB) market from 10% to 38% under Governor Haruhiko Kuroda’s watch, an amount now equal to 65% of GDP. The BOJ bought short-term JGBs from banks, the most willing sellers. This lifted short-term bond prices and lowered their yields into negative territory, jeopardizing the profitability of banks.
Today, all government bonds with a maturity of less than 10 years are negatively yielding. “The BOJ has bought all the government bonds that current owners are willing to sell at the current price,” notes Okubo. If the BOJ were to maintain the pace of purchases, it would need to bid up the price of JGBs, further depressing yields and profits at financial institutions—including the BOJ itself.
The next BOJ buys would likely be longer-dated government bonds owned by pension funds and insurance companies. Such firms must hold long-term JGBs to match against their long-term payout liabilities. Long-term interest rates would fall. The yield curve would flatten, jeopardizing the business models of pension and insurance companies. Not surprisingly, the financial industry wants to reverse negative interest rate policy (NIRP).
Loose monetary policy has so far achieved minimal success. Asset prices have risen, but the newly created wealth failed to stimulate the economy enough. Banks parked most bond sale proceeds at central bank accounts, rather than loaning them out to customers. Companies now sit on a mountain of cash, rather than investing in people and projects. As a result, the government failed to achieve its 2% growth and 2% inflation targets. These are needed if Japan is to lower national debt to sustainable levels.
On September 21st, the BOJ announced it would manage interest rates, rather than target the rate at which it prints money. It set the 10-year target rate around zero percent. The BOJ aims to keep yields upward sloping—good for banks—while maintaining positive rates on long-dated bonds cherished by pension funds and insurers.
Okubo thinks the announcement indicates the BOJ has all but exhausted its means to stimulate the economy through further monetary easing and has decided to taper. “The BOJ is tapering, although they don’t want to admit it,” he says.
At the same time, the BOJ is trying to safeguard profitability of the financial industry on which the functional economy depends. “The BOJ feels that they cannot allow the yield curve to flatten out, as it may leave too many financial institutions unprofitable, endangering the financial system as a whole,” says Okubo.
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