Silicon Valley Bank’s ‘Swimming Naked’ Moment Is Spooking Japan

Anyone wondering why the Bank of Japan (BOJ) hasn’t had the courage to raise rates these last 20 years will find clues in the collapse of Silicon Valley Bank (SVB).

Events in Santa Clara, California would seem at some remove from the BOJ headquarters 5,100 miles away. But the worst U.S. bank failure since 2008 also has its roots in the Federal Reserve doing what the BOJ hasn’t: normalizing monetary policy.

SVB’s downfall bears many fingerprints. Donald Trump’s, for one. The deregulation bill the former U.S. president signed in 2018 exempted SVB from more stringent stress tests. And SVB’s leaders just inspired a Harvard M.B.A course on how not to manage a balance sheet. Hedging, anyone?

But the Fed’s most aggressive tightening cycle since the mid-1990s was the real catalyzing event. As Fed Chairman Jerome Powell hiked borrowing costs in 2022 and early 2023, SVB’s poor governance became impossible to hide.

It was an ideal distillation of Warren Buffett’s famous observation that “you never know who’s swimming naked until the tide goes out.” Well, there was some serious fiduciary skinny dipping going on amongst SVB CEO Greg Becker’s team.

Yet this tide-going-out scenario is precisely what’s been panicking the BOJ for 20 years now. And anyone betting the incoming BOJ leader Kazuo Ueda is going to be a monetary maverick isn’t thinking things through.

In 1999, Japan’s central bank became the first to slash rates to zero. In 2000 and 2001, the BOJ pioneered quantitative easing. It’s been trapped there since. Other than a fleeting 2006-2007 effort to hike rates a bit, the BOJ has gone further and further down the QE rabbit hole.

Over time, free money became part of the filament. Banks, companies, insurance funds, pension funds, universities, endowments, the giant postal system and the government took free money for granted. And at a high cost. Two decades of QE weakened Japan’s animal spirits.

The BOJ’s giant ATM took the onus off government after government to cut bureaucracy, loosen labor markets, catalyze a startup boom, increase productivity, empower women and attract more foreign talent.

In 2012, voters brought Shinzo Abe’s Liberal Democratic Party back into power amid promises of a reform Big Bang to defeat deflation. It was no coincidence that a year earlier, China had surpassed Japan in gross domestic product terms.

Rather than roll up his sleeves, Abe rolled out a new BOJ governor in March 2013 to shift QE into a higher gear. Haruhiko Kuroda did just that, flooding the world with yen. By 2018, Kuroda had supersized the BOJ’s balance sheet to the point where it topped Japan’s $5 trillion economy.

That propped up GDP here and there and generated record corporate profits thanks to a plunging yen. But a decade on, the Kuroda legacy is one of lost opportunities and tricky side effects.

Far from reflating Japan, Kuroda’s free-flowing cash reduced the urgency for corporate executives to innovate, restructure, improve corporate governance and take risks. And at the worst possible moment, as China stepped up policies to build economic muscle.

For this, Kuroda gets less blame than the politicians who set him up for failure. Had Abe’s party put some big supply-side reforms on the board Japan might not be watching India and Indonesia beating it in the race to produce tech “unicorn” startups.

Women, one half of the 126-million-person population, might not be falling further behind. And workers who this year might finally be getting a notable wage bump are grappling with the worst Japanese inflation. Unless higher salaries are matched by increased productivity, they will exacerbate Tokyo’s inflation problem.

It was Vladimir Putin’s Ukraine invasion that ended Japan’s deflation, not the BOJ. And it’s the “bad” kind, leaking in via elevated global energy and food prices.

This is the economic minefield into which new BOJ Governor Ueda must step next month. And the SVB failure will only add to the BOJ’s fears of creating its own banking mess.

Japan is awash in too-big-to-fail banking behemoths. But the government has long known that the real vulnerabilities are Japan’s roughly 100 regional banks, which at the start of the pandemic held nearly half of all deposits in the world’s third-biggest economy.

For years, profits at these institutions have dwindled thanks to zero rates and aging, shrinking population. Government after government urged regional lenders to consolidate to avoid collapsing. Tokyo pleaded with them to cut costs and strengthen balance sheets. It offered incentives to merge, including paying additional interest on lenders’ BOJ deposits.

It’s been a very long slog, though. All this is very much on the BOJ’s mind as some global investors bet on a U-turn from 20 years of QE. A big challenge for Ueda will be gauging the skinny-dipping factor, in the Buffett sense, among regional lenders.

Along with being a systemic risk, fragile regional players are also where BOJ liquidity goes to die. Larger, stronger, more confident regional players might lend more, increasing the BOJ’s firepower.

If current Prime Minister Fumio Kishida has a plan to stabilize Japan’s financial system and recalibrate its engines, now seems a great time to let global investors know. This complacency will limit new BOJ leader Ueda’s desire to craft a more rational monetary policy.

The SVB debacle 5,100 miles from Tokyo is a wake-up call for Kishida’s party and the BOJ that it’s high time to normalize the economy. The naked truth hurts.