In the chart below we see the Japanese government’s benchmark interest rate from 1972 to 2016. Over more than 20 years Japan has kept interest rates below 1%. During this time it has learned not only that it is able to successfully manipulate interest rates to nearly nothing, but that it can do so even while posting huge budget deficits.
The next graph is from Japan’s Ministry of Finance showing the last 27 years of Japanese government borrowing. Looking at the generally rising dotted line, the percentages attached there show the percentage of each year’s government spending that was paid for by issuing bonds. So for instance, in 1991, just 7.6% of government spending was financed by floating bonds. That percentage rose rather steadily over 20 years and peaked at about 48% in the early years of this decade. The percentage fell to 38.3% in 2015, but still represents a staggering budget deficit.
The inevitable result of massive yearly deficits is massive accumulated debt. Below is a chart from the Economist showing the growth in Japanese government debt compared to the U.S., Britain and the Eurozone. The numbers reflect the amount of outstanding government debt as a percentage of Gross Domestic Product (GDP). Ideally, there would be no increase in these percentages or even declines as governments limit spending increases to no more than economic growth. Japan has certainly not followed such a principle. Compared to the size of its economy, Japanese debt outstanding has now more than tripled since the early 1990s. In absolute numbers, Japanese government debt outstanding now surpasses $1 quadrillion yen (or more than $10 trillion US$), the most of any country in the world except the U.S.
Japan’s stock market too, does not reflect a country with past or promising economic growth, but one mired in a more-or-less continuous 25-year recession. The Japanese stock market, and its economy, was once the darling of the world. During the 1980s there was no developed market with higher growth rates. But after more than 25 years since then, Japanese investors are still waiting to be made whole. As I write this the Nikkei 225 is at 16666, roughly the level of their stock market in 1986. I’m sure there are still some investors in Japan that have stayed the course in their stock market for 30 years, waiting with incredible patience, perhaps too much. The demographic trends and monetary foolishness there nearly ensures that those investors will never see a positive return on their money, after accounting for decades of inflation and lost opportunities.
After Japan’s economic and financial bubble of the 1980s burst, the Japanese authorities did not know any other way to attempt to recapture growth rates of old so they turned to the two things that outdated dusty economic textbooks told them would restore robust economic growth to its shores: low interest rates and (government) deficit spending. And if low interest rates and deficit spending are the key to strong economic growth then really low interest rates and really high deficit spending should produce very strong economic growth.
More than two decades into the experiment, where are the economists pointing to the example of Japan that such ideas and actions works? Today, Japan joins others at the forefront of new frontiers in financial foolishness as they lower interest rates into negative territory, demanding payment for the privilege of holding money in their banks. Japanese 1-year government bills now pay negative interest, as do all their government bonds all the way up to its 10-year bonds. It is difficult to conceive of someone “investing” his or her hard-earned money into the Japanese government for ten years and then at the end of that time, getting back less than started with. Who would have imagined that the most government-indebted developed nation could pay negative rates on its interest?
Perhaps few would have imagined but governments are sure glad of such insanity. Unfortunately, today’s insanity means tomorrow reality will include more of the same. As Japanese officials have learned that they can add massive budget deficits each year onto its debt pile and is still able to find buyers for its debt at 0% (or now negative) interest rates, it has removed any restraint in terms of government spending. Despite Japanese government budget deficits routinely exceeding 30%, government debt of more than 200% of GDP, and supposedly (roughly) 0% inflation, the Japanese government continues to spend more each year, not less.
The case study that we have been given in Japan, shows that extremely low interest rates, high taxes and large deficit spending does not in fact result in strong and consistent economic growth, but in lower and more volatile economic growth and financial markets. However, the governments practicing such silliness see that they can have a greater hand than ever before in managing and manipulating the economy and the financial markets. Despite the pain and misery their actions cause millions, such a position of control is too promising to pass up.
During the 1990s the U.S. was more or less a bystander on the ways of Japanese financial and monetary experimentation. When they did get involved it was generally critically, such as in the late 1990s when U.S. government officials warned Japan of the mistakes they were making and the long-term dangers of its financial recklessness. But now the U.S. government has learned from observation what the Japanese learned from experimentation. Japan has been the laboratory and the U.S. is now very willing to take advantage of the information learned.
Below is a graph of the U.S. Fed Funds interest rate going back to 1990. We see the significant lowering of interest rates after the early-90s recession, the rise during the economic recovery and stock market bubble, the deeper lowering of rates after the tech-bubble collapse, the subsequent rise during the mid-2000s recovery and finally the collapse in rates after the financial panic of 2008. At this point there is almost no chance of a return to normalized interest rates.
In case there is doubt on that last point, observe the first graph in this article. Japan has been unwilling to raise interest rates in anything other than a nominal way after more than 20 years and is in fact lowering them to record lows this past year. The U.S. is following the path of Japan with regards to government spending and low interest rates. Large yearly budget deficits: check. According to the U.S. Debt clock (usdebtclock.org), the current level of U.S. federal debt is $19.2 trillion, up from $10.1 trillion eight years ago. That’s eight years averaging more than trillion dollar deficits.
(Nearly) zero percent interest rates: check. The U.S. government/Fed Reserve has kept interest rates under 0.50% for more than 7 years. The economy and financial markets are now so dependent on nearly free money that even a .25% rise is barely tolerated by the market. Traders currently expect the Fed Funds rate to remain below 1% in two years. Perhaps they will still be below 1% in twenty years, following the path of Japan. As Japan has shown, there is little reason for the government to change its ways.
There is a new world order. In the past, the U.S. (and Japanese) government had to be careful to limit deficits or be at risk of angering the bond “vigilantes” who would punish those governments carrying large budget deficits in the form of higher interest rates. In the past, government (central bank) officials could control short-term interest rates but were at the mercy of bond traders when it came to the level of longer-term interest rates. They had to keep both inflation and spending under control.
But today government debts don’t matter. They’ve been ignored in Japan for 20 years and for most of a decade in the U.S. And those bond vigilantes have become bond buyers, teaming up with the Fed to keep rates on the floor. Today, central banks still control short-term interest rates but they also control long ones too, through jawboning, obfuscation, and direct manipulation into the bond market.
The old order of fiscal prudence and monetary discipline is over. Governments are content to have their countries become zombies with concealed inflation, weak economic growth, financial and economic bubbles and busts, increased industry control and general dissatisfaction. Governments around the world have studied the Japanese financial model and have found it to their liking.