Analysis | Somewhere in the Multiverse, SVB Could Be the BOJ

Last week, some traders feared a surprise move by the Bank of Japan to dismantle yield-curve control. Unfortunately, such a move would have compressed into a single weekend the mistakes of predecessors who raised rates at the wrong time. Fortunately, in our universe, Governor Haruhiko Kuroda exercised considerable prudence over tightening policy despite pressure from overseas investors to abandon yield-curve control and join the global cycle. This article will discuss the potential implications of such a move and explore how a country dependent on free money for three decades could be in trouble.

The Risks of Abandoning Yield-Curve Control

If the Bank of Japan had made a surprise hawkish turn just as Silicon Valley Bank (SVB) collapsed, chaos would have been unleashed. SVB’s collapse was caused by assumptions going wrong when a generation of investors who had been successful while rates were near zero encountered something many had never seen before: a rapid series of interest rate hikes. This scenario begs the question, what would happen in a country where money has been free for the best part of three decades? This is a situation that the Bank of Japan has tried to avoid by exercising caution and prudence over tightening policy, despite pressure from overseas investors.

Japan and Silicon Valley have little else in common, but one thing that unites them is their dependency on easy money. So assuming that not just venture capitalists but also households and the government are deeply dependent on cheap money, a failure of a mid-sized bank in Japan could look worse than the collapse of SVB.

The Risks of Raising Rates in a Global Downturn

In 2000, after much hand-wringing and despite government opposition, the BOJ lifted its rate from zero, only to rescind the step the following year. Governor Masaru Hayami was never able to recover his standing after that fiasco. When the BOJ next lifted rates, it was on the eve of the global financial crisis, which ended badly. Today, global growth is slowing, and while it’s not falling off a cliff like it was during the financial crisis, there are still concerns.

The Federal Reserve is expected to hike rates next week, but in a nod to the desire for financial stability, a 50-basis-point step looks unlikely. Instead, a quarter-point nudge is a sensible compromise. The European Central Bank is also expected to continue its fight against inflation.

Related Facts

• SVB’s collapse was caused by assumptions going wrong when the bank’s investors, who had been successful while rates were near zero, encountered something many had never seen before: a rapid series of interest rate hikes.
• The Bank of Japan has exercised caution over tightening policy, despite pressure from overseas investors.
• A failure of a mid-sized bank in Japan could look worse than the collapse of SVB.

Key Takeaway

The collapse of SVB showed that assumptions could go fatally wrong when investors experience something they haven’t seen before. However, there are reasons to be cautious about raising rates and abandoning yield-curve control in the current landscape. The situation in Japan, where money has been free for three decades, could be particularly risky.

Conclusion

While we cannot predict what might happen in a parallel universe where the Bank of Japan has abandoned yield-curve control, we know the risks of doing so are high. Japan’s economy, households, and government are deeply dependent on cheap money, and a mid-sized bank’s failure could create a crisis that makes the collapse of SVB look mild by comparison. In today’s global economy, central banks must exercise caution and think long-term rather than focusing on short-term gains that could prove catastrophic.