X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
A Broken Bond - II - Outside View by Nitin Gregory

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

A Broken Bond - II
Sep 24, 2016

The bond market today is in uncharted territory. They're the target of central bank quantitative easing and are today at record highs. By some estimates, US$13 trillion worth of bonds have negative yields. The yield on ten-year treasuries is lower than the dividend yield on the S&P 500.

The bond market of Japan remains the most curious. Bond yields in Japan have been low for a long time, but now they've turned negative. And the BoJ governor recently announced a cap on 10-year bond yields.

Japan has been a great case study for various stages of economic growth. The fast rise of japan in the late twentieth century is a template for catch-up growth. Today, however, the stagnant and debt-laden economy could be a case study of a completely different kind.

What is a liquidity trap?

A liquidity trap is a situation where monetary policy becomes ineffective. Lowering interest rates usually results in increased private investment. But the effect has diminishing returns. An economy enters a liquidity trap when interest rates are already very low and further decreases do not have a positive impact on the economy. Japan is an acute case. Interest rates there have been below 2% since 1998. Why haven't these low interest rates increased private investment?

 liquidity trap chart

The private sector has preferred to hoard cash. Net business debt has been falling. And by some estimates, the cash held by Japanese firms has reached $2 trillion. The lack of investment can be attributed to private deleveraging. After the crisis in 1989, the private sector paid down debt. While the debt position has improved, the private sector has not started investing in the Japanese economy. Primarily because demand in the economy is almost impossible to gauge.

The 80's were characterized by build of corporate debt and a bubble in the real estate sector. This mal-investment in the system has not been fully purged. Private sector debt has been replaced by public debt. This means the demand in the economy is dependent on continued deficits and more public debt. In this scenario of uncertain demand, the corporates are rightly cautious about domestic investments. Japanese companies are looking for investments abroad.

Academic theory suggests two ways out of a liquidity trap. The first is to build 'bridges to nowhere', or provide 'fiscal stimulus' as the academics prefer to call it. The idea is that the liquidity created by the central banks is not reaching the economy. Nobody wants to borrow and invest because the demand situation is so unclear. So, the argument goes, the government has to engage in public works and fixed investment. This means more roads, railways, and bridges - even if they're unnecessary.

The second remedy is what the academics call 'unconventional monetary policy' and what I call 'Peter Pan's Flight'.

BoJ Governor Kuroda once told an audience, 'I trust that many of you are familiar with the story of Peter Pan, in which it says, "The moment you doubt whether you can fly, you cease forever to be able to do it."' He was referring to the current crisis of confidence. His comments are meant to assure investors that the BoJ is committed to stoking inflation. The bank intends to overshoot its inflation target. A sign of rising inflation will not result in a subsequent rate hikes (which is the common practice).It means holding the rates low in the face of inflation to ensure negative interest rates. Will this help galvanize demand and investment?

Paul Krugman, in his 1998 paper, Japan's Trap, refers to this as 'unconventional monetary policy'. It talks about central banks establishing credibility that they will be 'irresponsible' and overshoot their inflation targets.

Japan has been a great experiment for the world. Its economy - with its indebted government, deleveraging private sector, demographic challenges, low rates, and no inflation - is leading the way for the rest of the developed world. Will 'Peter Pan's Flight' work? How long will Japan believe it can fly? The world is watching.

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "A Broken Bond - II". Click here!

1 Responses to "A Broken Bond - II"

Rajiv

Sep 26, 2016

Yes, I simply love such informative articles...and pls do bring mire of such insightful writings that enlighten us about the tough Economics jargon in simple to understand language. Do convey my appreciations to the young writer Nitin Gregory.

Rajiv from New Delhi

Like (2)
  
Equitymaster requests your view! Post a comment on "A Broken Bond - II". Click here!

More Views on News

BSE Sensex at All Time High; ONGC Among Top Gainers (Market Updates)

Jul 18, 2018 | Updated on Jul 18, 2018

Markets all time high analysis : The bse sensex at all time high; ONGC among top gainers. Find the latest update, special reports and news on all time high gainers of BSE Sensex at equitymaster.com.

BSE Sensex at All Time High; ONGC Among Top Gainers (Market Updates)

Jul 18, 2018 | Updated on Jul 18, 2018

The BSE Sensex has hit an all-time high at 36,748 (up 0.5%) with ONGC among the top gainers.

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

Is Mutual Fund Categorization Affecting Your Portfolio? Review It Now! (Outside View)

Jul 18, 2018

PersonalFN explains why a mutual fund portfolio review is necessary, particularly after the regulator's mutual fund categorisation norms.

A Sense of Melancholy (Vivek Kaul's Diary)

Jul 18, 2018

...

More Views on News

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

New Fund Offer - ICICI Prudential Pharma Healthcare and Diagnostics Fund - Should You Invest?(Outside View)

Jul 6, 2018

ICICI AMC launches an open -ended equity fund following Pharma, Healthcare, Diagnostic and allied theme.

When Disappointment Panda is Around. Buy Quality Stock like This!(Chart Of The Day)

Jul 6, 2018

Buy Companies that can fight all kinds of Pandas and Bears in the long run.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jul 18, 2018 (Close)

MARKET STATS