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Japan: Negative Rates Redux

The recent history of Japan (and Europe) shows that negative interest rates do not yield positive economic results

by Nico Isaac
Updated: January 29, 2016

Exactly one week after denying the need to "adopt a negative interest rate policy" on January 21 --  Bank of Japan governor Haruhiko Kuroda decided on January 29 to, well, slash interest rates into negative territory.

The about-face decision ignited a media frenzy, with pundits from Wall Street to Tokyo racking their brains as to why Kuroda changed his mind in favor of the radical move.

Their consensus is two-fold: first, Kuroda simply fast-tracked the inevitable; negative rates were a matter of when, not if. And second, the move, while shocking, is the last best chance at reigniting Japan's faltering economy. Writes one news source:

"Negative rates dissuade lenders from parking cash with them. The hope is that they will use that money to lend to individuals and businesses which in turn will spend the money and boost the economy and contribute to inflation." (Jan. 29 MarketWatch)

Here's the problem. This isn't Japan's first go-round in the negative rates rodeo. In fact, Japan is following in the free money footsteps of Europe, who in 2012 was following in the free money footsteps of none other than -- Japan.

At the time, our August 2012 European Financial Forecast published a special report on the history of negative interest rates -- and anticipated its inevitable failure:

"Our opinion is that negative interest rates are nothing more than a mile marker in the Continent’s relentless march toward outright consumer price deflation, and this chart of Japanese stock, bond and consumer prices over the past two decades shows why. Notice that Japan’s short-term yields first went negative way back in January 1997, seven years after the Nikkei’s all-time high and with Japanese stocks still levitating 54% above today’s prices. Today, more than 15 years after negative rates first appeared in Japan, the Nikkei is down, government bonds still pay next to nothing, and the Japanese economy regularly grapples with painful periods of consumer price deflation.

"Despite this relatively recent example, European leaders seem determined to replicate Japan’s experience. 'The time of partial solutions and piecemeal reform is over,' says ECB Executive Board Member Benoit Coeure, telling reporters that the ECB may cut deposit rates below zero. With the Japanese experience as a stark reminder, such an action will surely be in vain: Just as night still follows day, credit busts still follow credit bubbles, and, no matter how powerful they may seem, central banks cannot circumvent the immutable laws of finance."

So, what happened from there?

Well, apart from accommodating a credit-fueled revival in equities (in both Japan and the eurozone), negative rates were futile in pulling the mutual economies out of the morass of falling inflation, wages, GDP, and overall growth. Here, our October 2015 European Financial Forecast shows the unmitigated downtrend in Europe's largest economies over the last decade:

Now, Japan is recycling its negative rate policy in hopes of averting a deeper economic contraction. Only this time, they're not leading the free money parade -- they're following it.

In our opinion, the policy will have about the same non-effect as it did the first -- and second time. In the words of Bob Prechter's 2014 edition of Conquer the Crash:

"A defensive credit market can scuttle central banks’ efforts to get lenders and borrowers to agree to transact at all, much less at some desired target rate... During deflation, they cannot even induce them to do so with a zero interest rate."

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