This Week In Finance

One Percent Bond Yields: It Can't Happen Here - Can It?

"Japanese Intermediate-Term Government Bond Yields Reach Record Low: 1.6 Percent"

A recent piece in the November, 1997 issue of the Federal Reserve Bank of St. Louis' "International Economic Trends" provides some interesting food for thought. The yield-t-maturity on Japanese ten-year Treasuries is 1.605%; by comparison the yield on analogous U.S. Treasuries is a little over 6% - nearly quadruple that of the Japanese bonds! According to the article, the incredibly low yield-to-maturity on Japanese government bonds is due to several factors.

First, according to the Fisher Effect (see Chapter 7 if you're using RWJ's Fundamentals 4e or Chapter 10 in RWJ's Essentials,) long-term bond yields are, in part, a function of market participants' inflation expectations. Since recent increases in the Japanese CPI have been near zero (the argument goes), inflationary expectations and investors' required returns have been dampened.

Second, because of the protracted and continuing recession in Japan, the demand for capital by business has fallen.

Finally, a falling Japanese goverment deficit has resulted in the issuance of fewer 10-year bonds, driving the prices (yields) of existing bonds up (down).

Now consider the following. There is a great deal of talk in this country about the dangers of "deflation" and/or "disinflation." (Sidepoint: as usual, many journalists don't understand basic economics and fail to distinguish between the two. "Deflation" refers to actual price decreases, as was observed during the Great Depression of the 1930s; "disinflation", on the other hand, refers only to reductions in the rate of increase in prices.)

In any event, the result should be declining bond yields, cet. par. (And indeed, the secular trend in Treasury yields has been downward since the late 1980s.)

And the government deficit is projected to disappear not too long after the turn of the century, which would lead one to expect reduced debt issuance by the U.S. government.

Perhaps the biggest difference between Japan and the U.S. at the moment is that the latter's economy is something of a mirror image of the former.

So what's the bottom line? Are we headed down the same path as the Japanese? Some would say that the macro-factors are similar, and that we should be careful. Others would pooh-pooh the idea, noting that the financial and regulatory infrastructures of the two countries are far too different to make a simplistic comparison on the basis of a small number of factors. But, most important: What do your students say?

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