The Curious Case of the Bank of Japan
How the Bank of Japan is uniquely able to conduct the most aggressive monetary policy that the free world has ever seen.
Over the past decade, the Bank of Japan has directly and indirectly printed trillions of US dollars and a lot of this money has gone into the US economy.
Miraculously, the Yen has not crashed.
Here’s why.
The Bank of Japan has been the most egregious money-printer of any central bank in the G20. In fact, no G20 central bank comes even remotely close to the BoJ’s seemingly reckless money-printing.
For one, the BoJ has kept its policy interest rate below 0% since 2016, even stubbornly keeping it below zero over the past four years when every other central bank was furiously hiking their own rate.
If one thought the Federal Reserve’s pace of Quantitative Easing (QE) over the past decade was excessive, the BoJ’s pace of QE, relative to the Japanese economy, would blow your mind.
The BoJ expanded its balance sheet from around $1 trillion USD in 2012 to over $5 trillion USD now.
This was the result of non-stop regularly scheduled QE operations in addition to a very radical policy called Yield Curve Control (YCC) where the BoJ essentially forces long-term interest rates into a desirably low range through the very heavy-handed application of QE. No other G20 central bank does YCC.
And if this wasn’t enough, the BoJ also regularly buys Japanese stocks and corporate bonds through QE. Again, the BoJ is unique among the G20 central banks in doing this.
In this article, we’ll go over why the BoJ chooses to engage in such an exceptional monetary policy, how things could go wrong, why hasn’t it gone wrong, and how this ultimately relates to the US stock market.
In doing so, we’ll also discuss two timeless Japanese cultural concepts that, in large part, enable the BoJ’s exceptionalism:
Danshari (断捨離): the elimination of mental and physical clutter to simplify life.
Kodawari (こだわり): the uncompromising and relentless pursuit of perfection.
Why Print So Much Money?
Japan’s inflation rate has been stubbornly low ever since the late 80s.
Low inflation is bad for economies, and for good reason.
For one, low inflation is a sign of weak economic growth. Inflation naturally shows up when consumer demand rises and there’s more consumer spending. When the economy stops growing, consumer demand wanes, and inflation recedes.
Secondly, Japan is an export-driven economy and low inflation results in a strong currency. This makes their exports more expensive and less competitive globally, which in turn hurts economic growth.
Finally, prolonged low inflation also changes people’s expectations and encourages people to hold on to too much cash. When cash stops moving in the economy, the economy slows down. Not good.
The reason that the BoJ maintained its drastic money-printing policies for over a decade was in the service of reviving inflation in the Japanese economy.
$5 trillion and years later, we see that these efforts have surprisingly been only mildly effective.
What Could Go Wrong?
By all measures, the BoJ’s policies are incredibly drastic and border on recklessness.
Unmitigated money printing is a surefire way of breaking national financial systems, causing the currency to collapse and the government to default.
A classic way the collapse could happen is if inflation in Japan soars out of control and confidence in the BoJ breaks, causing domestic and foreign investors to divest from the Yen and Japanese debt.
This will cause Japanese interest rates to uncontrollably skyrocket.
The best way the BoJ could wrestle down interest rates is to print Yen to buy Japanese debt. However, with investors selling Yen, printing more Yen will only cause further currency devaluation. When the Yen falls, investors will also sell more Japanese debt, pushing interest rates up. This is known as a currency and debt devaluation spiral.
This devaluation spiral is a nightmare scenario of every central bank. A central bank has very little tools to recover from this spiral once confidence in the bank is gone.
If unmitigated, the spiral leads to a painful national bankruptcy.
Why Hasn’t It Gone Wrong? The Indestructible Yen
This is the fascinating part of the whole story.
The Yen is miraculously able to stay afloat despite the BoJ’s best efforts to devaluate the currency for over a decade.
How is this possible? It’s certainly a head-scratcher.
Adding to the intrigue of The Indestructible Yen is the vanishing of Japan’s once-mighty trade surplus. In the last decade, Japan’s balance of trade has been anemic, having mildly recovered from a disastrous collapse in the first few years after the 2008 financial crisis but it has never recovered to its prior highs.
As such, the trillion-dollar question is, if large export incomes is not paying for the Bank of Japan’s exorbitant money-printing, what is?
The answer to this question has three parts.
First, a quick exploration of Japanese culture can help us understand how inflation and wages have remained stubbornly low in Japan. Low inflation is a key underpinning of continued confidence in the Bank of Japan.
Second, we’ll see how Japan’s once-mighty status as an export power is actually paying for a lot of the Bank of Japan’s profligacy today. Today’s Japan is, in effect, withdrawing from a gargantuan bank balance it has built up through decades of substantial trade surpluses from 1980 to 2008. This aspect of the Japanese economy is something that’s surprisingly rarely mentioned in other financial media.
Third, there are several tertiary factors that also contribute to keeping the Yen afloat, like a massive tourism industry and rising Japanese company buybacks.
Let’s dive in.
🧘 Danshari and Kodawari (Productivity and Consumption in Japanese Culture)
Two timeless Japanese cultural concepts, Danshari and Kodawari, help explain Japan’s stubbornly low inflation and low wages.
Danshari (断捨離) is the elimination of mental and physical clutter to simplify life. This idea of minimalism and simplicity permeates Japanese culture, discouraging excess and upholding material discipline.
It’s no wonder that, despite a relatively wealthy society, ultra-low interest rates, and the free-flow of central bank money, Japan’s domestic consumption remains stubbornly low. This is particularly telling when comparing Japan’s private consumption as a % of GDP to other developed countries:
United States: 68.2% in Q4 2023.
United Kingdom: 62.7% in Q3 2023.
India: 63.6% in Q4 2023.
Japan: 53.5% in Q4 2023.
Note: Japan’s private consumption rate is low but it’s certainly not an exception. There are other developed countries with similar private consumption rates.
Kodawari (こだわり) is the uncompromising and relentless pursuit of perfection. This virtue permeates the Japanese workforce and underpins the country’s multi-decade stagnation in wages.
Japanese workers are compelled to do a good job, just for the sake of doing a good job. They have a very craftsman-like attitude to work so even if wages don’t rise, the work still needs to be done at a high quality bar.
With Japan’s innovation and productivity waning amid staunch competition from China, South Korea, and other upstart East Asian nations, many Japanese corporations have been forced to suppress wages to maintain profit margins and keep exports competitive. They’re able to do so, without much revolt from the workforce, partly because of kodawari.
To summarize, an ascetic (but aesthetic) lifestyle and a pursuit of excellence are exceptional virtues that help enable exceptional central bank policies.
🕰️ Living on Past Glory
While Japan’s balance of trade shows waning flows of money into the country, this is far from the full story.
When we zoom out and look at Japan’s balance of payments (aka current account), which encompasses all flows of money in and out of the country, we see a completely different story.
While exports have weakened in the past decade, Japan’s balance of payments remains consistently and substantially positive. This positive balance of payments plays a significant role in keeping the Yen afloat.
But if exports are not helping with the balance of payments, what is?
I had to dig for this but finally found the answer when I saw this current account chart in a document published by the Bank of Japan titled “Japan's Balance of Payments Statistics and International Investment Position for 2022”.
Do you see what I see?