By holding interest rates close to zero, Japan has been been the global carry-trade's best friend, fostering liquidity worldwide for purposes, mainly, of promiscuous financial speculation. However, the Bank of Japan recently announced that zero-interest rate conditions will end later this year, a prospect that is likely to add some deflationary ballast to a financial environment that has been gaseously buoyant since around the mid-1990s. I recently heard from a correspondent on this topic, a financier who wishes to remain anonymous. He posted the following to a chat group that I frequent: 'How will the Japanese financial markets be returned to a 'normal' state of liquidity? I had the opportunity to attend a symposium this afternoon, hosted by a primary dealer as well as some representatives from several GSEs and supranational agencies, and an active topic of discussion was the impending change in Japanese monetary policy. The Bank of Japan has indicated that during 2006, zero-interest rate conditions will almost certainly come to an end. What was not widely known amongst the participants was that the BOJ has expressed that it intends to have the banking system eliminate its excess reserves over just THREE MONTHS, probably around the third calendar quarter of 2006. 'One of the main policy tools that the BOJ has used over the past several years has been to inject (and to take steps to maintain) over Y34 trillion of reserves in current account deposits (similar to the reserve requirements in the US) for its member banks. The statutory reserve requirement for these banks is but a mere Y5.5 trillion, so the Y28.5 trillion ($241 billion) above and beyond the required minimum is invested in a wide variety of money market instruments, a substantial portion of which consists of US$ assets, or term repurchase agreements collateralized by
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