By Tim Maverick
Japan may be the Land of the Rising Sun… but in terms of monetary policy, it's the land of falling interest rates. Negative interest rates, to be precise.
As damning economic indictments go, it doesn't get much more doom and gloom than what the Bank of Japan did recently. It lowered interest rates on additional deposits made by banks to negative 0.1%.
In doing so, it joined the European Central Bank (ECB) and the central banks in Switzerland, Sweden, and Denmark in pushing their rates below zero.
The question is: Why? And what does it mean for the rest of the world and investors?
Japan Hits the Nuclear Button
Japan's version of quantitative easing (QE) isn't working. The Bank of Japan now owns one-third of all Japanese government bonds. And this is after buying an amount of securities equal to one-fifth of its annual economic output. Yet its economy is barely growing.
So in dragging interest rates below zero, it's another attempt to shock the economy into life. It probably won't work. The economic problems in Japan are more deep-rooted and systemic than any monetary policy can cure.
But that doesn't mean the bankers' decision doesn't have wider implications. In fact, the effects of this move are like a tsunami raging through the financial markets.
Over to You, China
Naturally, the Japanese yen suffered the main impact. It tanked. The yen dropped from 118 to the U.S. dollar to 121 quicker than you can say "currency war."
This pushed the dollar to a 13-year high versus a basket of 16 currencies. That's not good news for many U.S. companies, despite the stock market surge after the announcement.
Since 2012, Japan has devalued the yen by 50% since 2012 - from around 80 yen to the dollar to current levels. The reaction from the U.S. markets and government officials? A collective shrug.
Contrast this laissez-faire attitude with China's moves to devalue the yuan. It couldn't be more different! When China moved to devalue its currency by a mere couple of percent, it was treated like the end of the world.
Like some kind of currency tennis match, the Bank of Japan's move whips the ball firmly back into China's court.
I strongly believe it intensifies the economic pressure on China - and will again respond by further devaluing the yuan later this year. It will likely hold fire for now, though, pending the ECB's interest rate decision in March.
But China will act.
Wall Street Doubles Down on Yuan Tumble
Another factor holding China back from taking immediate action is that U.S. hedge funds have launched an all-out attack on the yuan, betting on its decline.
Case in point: Kyle Bass's Hayman Capital Management is embarking on mass liquidation in order to push its chips into attacking the yuan, according to The Wall Street Journal. Other big hedge fund hitters, including David Tepper, Bill Ackman, and David Einhorn, have also bet against the yuan.
This is nothing new for Wall Street. It has history in smashing the currencies of smaller countries like Argentina.
I wouldn't be surprised if China tried to up the ante by pushing the yuan higher for a while, in order to drive out the bearish speculators. But then look out for fireworks on the downside.
At the moment, it costs about 6.57 yuan to buy a U.S. dollar. I've previously noted that I only expect a 3% to 4% yuan devaluation - to about the 6.83 level. But all bets are off now.
We could see a double-digit devaluation. In other words, the race to the bottom in currencies continues. That race will eventually include the United States.
Coming Soon to the United States: Negative Rates
For months now, I've warned that negative interest rates are in America's future, too. Former Fed Chairman Ben Bernanke agrees. In an interview with MarketWatch in December, Bernanke said, "I think negative rates are something the Fed will, and probably should, consider if the situation arises."
That came on the heels of New York Fed President Bill Dudley telling CNBC in November, "Maybe we can use negative rates." So despite the Fed raising interest rates in December, don't be fooled. Negative interest rates are already part of the Fed's game plan.
In his projections for Fed policy back in the autumn, Minneapolis Fed President Narayana Kocherlakota had penciled in negative rates in the not too distant future.
The bottom line here? Desperation. That is, the increasing desperation of central banks around the world to offset the effects of poor policies that create too much debt (the debt super cycle).
Eventually, I think we'll see something akin to the Plaza Accord of 1985 to fix the current currency mess. Maybe it will be called the "Shanghai Solution."
P.S. One more thing: The Bank of Japan's decision to take interest rates negative sent some investors scurrying for the "safety" of government bonds - a move that lowered yields again. Currently, negative yields account for a quarter of JPMorgan's index of global government bonds. Absolute insanity.