As the Bank of Japan mulls its biggest policy pivot in roughly 25 years, no major economy may benefit more than China.
Here, readers may be thinking “Huh?” on two levels.
First, it’s true that Japan tried to get interest rates away from zero in 2006. That was seven years after it became the very first major economy ever to give zero a try, and about five years after the BOJ pioneered quantitative easing.
Yet that attempt to normalize rates failed. By 2008, Japan’s central bank was pushing rates back down to zero. This time, the enterprise is infinitely more daunting and dangerous given how much further the BOJ has ventured down the QE rabbit hole, particularly since 2013.
That was the year then-Prime Minister Shinzo Abe hired Haruhiko Kuroda to lead the charge as BOJ governor. Within five years, the BOJ’s balance sheet topped the size of Japan’s entire $4.7 trillion economy.
Today, withdrawing the BOJ’s role as top investment “whale” in both bonds and stocks without unleashing global chaos will be easier said than done. In fact, it will be nothing short of a shock to the global system. Any surge in government bond yields would make it harder for Tokyo to service the developed world’s biggest debt burden.
The second issue—why China might love a BOJ tightening move—concerns the yen. It would surge if current BOJ leader Kazuo Ueda pulls the plug at the March 18-19 board meeting—perhaps sharply.
Of course, sudden yen moves have a knack for shoulder-checking global markets. Two-plus decades of zero rates made Japan the globe's top creditor nation. Since the late-1990s/early 2000s, financiers of all stripes—hedge funds, especially—have routinely borrowed cheaply in yen and moved that cash into higher-yielding assets everywhere.
This so-called “yen carry trade” explains why sharp yen moves often reverberate through stock, bond, commodity and real estate markets from New York to Sao Paulo to London to Mumbai to Seoul. Given that bourses in China and Hong Kong lost around $6 trillion of market value from a 2021 peak to January of this year, you’d think yen-driven chaos is the last thing China wants.
Still, the chronically weak yen has been a real challenge for Chinese leader Xi Jinping.
Over Xi’s decade-plus in power, a top priority has been shifting growth engines from investment and property to technology and other higher-value-added industries. As China raises its game in autos, batteries, high-tech infrastructure, power plants, renewable energy and trains, the natural market for its products is other emerging markets.
Yet Japan’s 43% decline since January 2021 made Xi’s job harder. “To the extent that the BOJ may now be set to abandon its zero-interest-rate policy and yield curve control, and that this shift is likely to drive the yen higher, Chinese policymakers—and financial markets—can breathe a sigh of relief,” says economist Louis-Vincent Gave at Gavekal Dragonomics.
To be sure, weak economies tend to avoid a rising currency. When China’s biggest rival in the neighborhood has a far more advantageous exchange rate, things get dicey.
So far, Xi’s Communist Party has tolerated a stronger yuan to increase trust in China Inc. One of Xi’s other big projects is replacing the dollar in trade and finance. That becomes harder if Beijing is seen meddling too much in exchange rates.
“If the yen should start to rise, the outlook for China will improve dramatically,” Gave says. “Policy, geopolitics and financial markets will all start pointing in the same direction.”
Economist David Lubin at the Chatham House policy institute argues that “there’s a growing risk that deflation and weak economic activity might aggravate each other, creating a kind of ‘doom loop,’ where prices fall because demand is weak, and demand stays weak since Chinese households reckon it’s better to delay spending in the hope that goods and services get even cheaper.”
It follows, Lubin adds, that “all this should have some implications for Chinese exchange rate policy: a weaker [yuan] could raise the domestic price of imported goods by enough to help unroot China’s deflationary psychology before it really establishes itself.”
Thing is, China exporting deflation does have its perks for other major economies in the short run. In Washington, the weak pricing energy emanating from the biggest trading nation could help make inflation a bit more transitory for the Federal Reserve.
But for China, falling prices will just further undermine business and household confidence. It’s here where a rising yen could counter the headwinds zooming China’s way. And make China the real winner as the BOJ calls it quits on QE next week.
