Published in the Nikkei Asian Review 29/1/2016
You have to hand it to Bank of Japan Governor Haruhiko Kuroda. He has a grand sense of theatre. Not for the first time he has sent the financial markets into a tizzy by deploying a new and unconventional weapon of monetary policy.
Market participants likened his two rounds of large scale quantitative easing — announced in April 2013 and November 2014 — to the firing of a “big bazooka.” His latest ploy, the introduction of negative interest rates, is more like a shuriken throwing star aimed at the throats of currency traders who had been betting on a stronger yen.
Kuroda’s ninja-like skills of stealth and cunning were again in evidence. According to a Bloomberg survey, only six of 44 economists expected any action from the BoJ’s end-of-January meeting and not one expected an interest rate move. Kuroda had encouraged this sense of complacency with a bland speech at the recent Davos gabfest and some dismissive remarks about negative rates in December.
Economists who grumble about inconsistency and loss of credibility are missing the point. If the idea is to move financial markets, then surprise is an essential tool. By definition, what everyone is expecting — and what economists are predicting — is already in the price. Unlike Janet Yellen, the chair of the U.S. Federal Reserve, Kuroda is not aiming to soothe people into believing that the future will be little different from the past. He is attempting to trigger a radical change in the expectations of investors, corporate executives and households.
All Japanese under the age of 45 have spent their entire adulthood in a post-bubble environment in which risk assets such as equities and real estate were in bear markets, interest rates fell continuously and deleveraging was simply common sense. In April 2013, when Kuroda first deployed his big bazooka, prices in the Japanese economy were no higher than in 1980, as measured by the gross domestic product deflator. The early 1980s was also the last time there was sustained weakness in the yen.
Expectations are molded by experience, with recent experience having more weight than events in the dim and distant past. No surprise, then, that the Japanese public is skeptical that reflation is durable and the currency will remain soft. Hence the need for shock therapy. On several occasions Kuroda has stated that he will take “whatever measures are necessary.” Yet not even professional economists took him at his word. As recently as mid-December, nearly half of those surveyed by Bloomberg predicted there would be no further easing at all.
Perhaps the economists and other commentators were paying too much attention to the politics. A week before the BoJ meeting, the head of the Keizai Doyukai association of corporate executives demanded that no further easing measures should be taken. There are also “forces of resistance” within the central bank itself, as evidenced by the narrow 5-4 majority by which the new policy passed. Within Japanese organizations the usual approach to dealing with contentious issues is to water down your proposals and come to some kind of compromise. Under Prime Minister Shinzo Abe things are different. In monetary policy, as with security issues, the favored course is full steam ahead.
Deflation danger
Kuroda had to act because global deflationary forces are growing. Remarkably even Zimbabwe, once the poster-child for hyperinflation, is now in deflation. The slowdown in emerging economies — especially China, with its structural over-capacity — has intensified, and export volumes are declining in most Asian economies. The fall in commodity prices is a benefit to Japan — effectively a tax break. But just as higher commodity prices contributed to the inflationary psychology of the 1970s, lower prices today could imprint a deflationary message, especially if financial contagion spreads from commodity-dependent countries and companies.
Inflationary expectations — as measured by the gap in yield between inflation-adjusted and ordinary bonds — have been in sharp decline everywhere since last summer, and Japan is no exception. Early indications of the shunto (“spring struggle”) wage negotiations between unions and large employers suggest much lower settlements than in 2015. If the BoJ was to take its own target seriously, it had to respond. The only question was how.
The choice of negative interest rates is not as revolutionary as it seems. Real inflation-adjusted interest rates have been in minus territory since the dawn of Abenomics. As the BoJ noted in its explanatory remarks, Switzerland, Sweden and Denmark have been implementing negative rates for some time. Furthermore, the Japanese version will feature a complex system of tiers that will minimize the damage to banks’ profits while discouraging cash hoarding. Switzerland went aggressively negative 12 months ago to roll back excessive gains in its currency. It worked like a dream; the Swiss franc has since been weak against both the euro and the U.S. dollar.
Kuroda’s initial gambit of -0.1% is not that radical, compared to Switzerland’s -0.75% and Sweden’s -1.1%. But he has made it clear that he will not hesitate to raise the stakes if necessary. And which currency speculator would dare bet against him now?
Has the Kuroda-Abe policy mix been effective? Anyone who believes nothing has changed has simply not been paying attention. Nominal GDP growth of 3.5%, achieved in the third quarter of 2015, is the strongest performance Japan has seen in 24 years. Unusually, it is the lower end of the labor market that is seeing the clearest benefit. Part-time wages are currently rising at 2% a year, also the best growth in donkey’s years. The Bank of Japan’s “virtuous circle” of self-reinforcing wage and price gains has yet to establish itself, but the signs are encouraging.
What is needed to seal the deal is for the economic and psychological processes to be given time to work. And that in turn requires political stability, meaning an extended term for Abe, and an absence of policy blunders like the 2014 tax hike. Also from time to time we may need a few more ninja tricks to keep the markets on their toes.
