The next time anyone screams that Japanese bond yields are breaching all-time highs, calmly tell them that THE REAL YIELD IS STILL NEAR-ZERO.
Economies and financial markets are driven not so much by the nominal bond yield, but by the REAL BOND YIELD.
There are two related misconceptions that need to be cleared up:
First, debt sustainability depends on the difference between the bond yield and the growth rate of the economy, 'r - g'.
So, if the higher nominal bond yield 'r' reflects higher expected inflation rather than a higher real yield (as is the case in Japan right now), then nominal 'g' will rise by an equal amount as nominal 'r'.
Meaning, there will be no impact on 'r - g' and therefore NO IMPACT ON DEBT SUSTAINABILITY.
Second, owners of long-dated JGBs, such as insurers and pension funds, will be suffering large capital losses on their assets. Against this though, they will also be celebrating A COLLAPSE IN THE PRESENT VALUE OF THEIR INSURANCE AND PENSION LIABILITIES, based on the much higher discount rate.
This means there might be no impact on their solvency, or even an improvement in their solvency. So, the losses on their JGBs only matter if the insurers and pension funds must mark-to-market, which few actually have to do.
(Ask any actuary about this).
The two conclusions are:
1. Don't obsess about the Japanese nominal bond yield.
2. Focus on the Japanese real bond yield - which is still near-zero!
