"Turning Japanese" ..... by The Vapors, 1980

ref :- "The Fed and ECB Confront a New Normal That Looks a Lot Like Japan's" , Bloomberg Markets

Of the many interpretations of the lyrics of the Vapors biggest hit doing the rounds all those years ago, one or two may have been a touch salacious but the band themselves maintained that the song was merely a contemplation of youth and angst. This Bloomberg piece about how the rest of the developed world may be dragged into the economic quagmire that Japan has been mired in for so long has little to do with youth, but you could be forgiven if it left you fraught with angst. The Japanese economic model, so powerful when this song was released, has had an unhappy history over the last twenty years or so.

Yesterday the European Central Bank announced that contrary to the policy-line that it was publicly still adhering to until so recently, it will keep rates at record lows into next year and restart a cheap loan programme for banks. Plans to withdraw stimulus, formulated when things were going along nicely enough, thank you, have been undermined (torpedoed ?) by the slowing economy of the Eurozone and elsewhere. The US Federal Reserve has also had to backtrack on comparatively recent stated intentions, halting further rate rises and it seems to drop plans to continue to reduce its $4 trillion balance sheet beyond this year.

The authorities in both areas will hope that the change of tack is temporary, but the suggestion is that they are adjusting to a new and not very welcome "normal" ....  one of the historically low interest rates and swollen balance sheets accumulated through the process of adding stimulus after the last financial crisis. In other words, their future could well be very similar to the state of affairs that Japan has had to live with for decades.

There is speculation that the next policy moves by the two central banks will be to ease monetary policy rather than to tighten, as they fight to avoid the Japanese malaise of slow growth and low inflation. Everybody has their favourite view of the prime reasons behind the lack of inflationary pressure  --  Bloomberg cites ageing populations and feeble gains in productivity. Whatever the case, these are long-term issues but there is also a more immediate problem to deal with : the slowdown in global growth exacerbated by trade disputes, particularly in China, where efforts to de-leverage are likely to be undermined.

We can hope that any wobbles are short-lived  --  they have been in the past  --  but the biggest worry is that if the stimulus taps have to be opened once more, central banks have very little ammunition to bring to bear. Interest rates are already sub-zero, zero or just plain low. Balance sheets are bloated after central banks effectively created money out of nothing to purchase assets that with the exception of the small amount of Quantitative Tightening that the Fed has managed to get done so far. they still hold.

Of course , to lump everybody in the same boat is a bit lazy .... whilst it's only sensible to assume that the faltering global economy will affect that of the US, and that the effects of President Trump's tax cuts and spending will wear off, the US economy is still moving along nicely, and it has allowed the Fed to get interest rates up to a band of 2.25 - 2.50%. That's not miles away from what many believe to be the "neutral" rate of interest that neither stimulates nor holds back economic growth. Whatever the neutral rate is , these days it's much lower than we are historically used to but at least the Fed has a little room to manoeuvre. They've even managed to make a start on reducing the balance sheet, even if that process is soon to be halted. The ECB is not even close to balance sheet reduction, and with a base rate of zero and a discount rate of -0.4% it has next-to-nothing in terms of wriggle-room. And as for Japan ....

Interest rates in Japan hit zero 20 years ago, and have gone below that level since. The Bank of Japan's balance sheet, built up in an increasingly desperate attempt to spark inflationary growth, is larger than the entire national economy  --  and has not finished growing yet.

Plainly the Japanese example is not one that others are keen to follow, but to avoid heading down that route solid growth is required. At the very least, central banks need the chance to withdraw some of the stimulus pumped in post-financial crisis before they can start adding it again. The problem is that in this troubled world a period of solid global growth is not obviously in sight. There's angst for you ....