Published in Nikkei Asia 23/5/2022
Impressive social cohesion to keep price rises tame
You have to feel sorry for Bank of Japan Governor Haruhiko Kuroda. Just when he has finally hit his inflation target, after over a decade of trying and failing, he is being slammed by politicians and journalists for being responsible for the rise in the cost of living.
When Kuroda first took office in the spring of 2013, he signed an agreement with the government of the day promising to deliver 2% inflation. For most of the previous two decades, Japan had been mired in a deflationary stagnation which, let’s not forget, was accompanied by collapsing real estate prices, a record number of bankruptcies and a 50% surge in suicides.
Mounting costs are not an unfortunate side-effect of inflation. They are inflation itself. Nowhere in the world is inflation being led by higher wages. In every case, costs are rising with worker compensation growing at a much lesser rate. Japan remains the developed country with the lowest inflation, and there are good reasons why that is likely to remain the case.
Kuroda’s policies and the initiatives of then Prime Minister Shinzo Abe did put a stop to deflation, but until recently prices remained becalmed. This was a global phenomenon. Most central banks in the developed world found that inflation was coming in well below their targets, mostly 2% also, but this was generally treated as good news.
Indeed, a hubristic notion took root that inflation had been conquered for good, thanks to such structural factors such as demographics, globalization, the rise of online commerce and faith in the “forward guidance” of central banks.
Thus, the “Goldilocks scenario” – in which economic conditions are neither “too hot” nor “too cold”, but “just right”, like the young lady’s porridge in the children’s tale – would be a permanent state of affairs.
Now Goldilocks has left the building, suffering from a badly burnt mouth and pursued by a large number of bears. The “structurally impossible” view of inflation – strongly promoted by previous BoJ Governor Masaaki Shirakawa and other hard money advocates – has been comprehensively discredited.
Why has inflation suddenly burst out, contrary to the predictions of central banks and noted economists? The immediate trigger was the response of governments to the Covid pandemic, which was very different from the policies adopted to counter the Global Financial Crisis.
From 2008 onwards, the money collectively created by central banks via quantitative easing largely remained within the financial system. It may have had an impact on asset prices, but there was none on ordinary products as no new demand had been created.
In contrast, governments dealt with the economic trauma caused by Covid lockdowns by launching what were essentially money drops on households and companies. New buying power met supply blockages and, hey presto, suddenly there was inflation. Quite a lot of it, in fact.
Inflationary pressures have spread worldwide. The latest print of the consumer price index in the U.S. is 8.3% higher than the same month last year. In the U.K. the CPI is up 9%; 7.8% in India; 4.8% in South Korea; 5.4% in Singapore. Even Germany, once a pillar of financial rectitude, is recording CPI inflation of 7.4%, the worst reading since 1974. In this context, Japan’s 2.4% stands out like a good deed in a weary world.
An importer of nearly all its primary energy, Japan was hammered by the 1972 oil shock, with inflation spiralling to over 20%. Yet, by 1982 Japanese inflation had fallen to 3%, a full 8% lower than inflation in the UK at the time. It has never risen any higher since, except when consumption tax hikes caused distortions.
Why should that be so? Investment scholar Edward Chancellor offers some intriguing thoughts in a recent essay for Breaking Views. It is worth quoting at length.
“Inflation is always and everywhere a monetary phenomenon, Milton Friedman famously proclaimed. But what causes the abnormal growth of the money supply? Economists are silent on the matter. Sociologists have an answer. Inflation, they say, is as much a social as an economic phenomenon. According to British sociologist John Goldthorpe, inflation is a sign of social divisions – inflation, he writes, is the “monetary expression of distributional conflict.””
On that reading, inflation is an unconsciously willed outcome of the political process. You would expect to see the highest inflation in countries with the most fractured politics. In fact, rising populism would be a good signal of future inflation. “Distributional conflict” has long been a familiar phenomenon in Latin America and emerging Asia, but now we see it escalating in the U.S., the U.K. and the Eurozone.
On the other hand, countries which have uneventful politics and a high level of social cohesion, such as Japan and Switzerland, would not experience inflation as an inevitable consequence of political failures that have been long in the making. In the case of a “regime shift” to a world in which inflation is an ever-present possibility and threat, these countries would be relatively well positioned. They would likely be rewarded by strong currencies too, improbable though that might seem right now in Japan’s case.
Is such a regime shift likely to take place, or will inflation revert to trivial levels once the various supply blockages have disappeared? That is the most hotly debated subject in financial markets today. From this author’s perspective, it does seem that the tectonic plates of the world economy have shifted in a highly significant way.
Through most of this century, the economic shocks tended to be disinflationary, the accession of China, with its enormous labour market, to membership of the World Trade Organization being the biggest factor of all. But in recent years the shocks – the pandemic, the Russian invasion of Ukraine – have sent prices soaring
There are surely more such to come. If the logic of globalization was disinflationary, then de-globalization should have the opposite effect. Likewise, the government and ESG (Ethical, Social and Governance) mandated target of zero net carbon emissions could turn out to be a major driver of higher costs
No doubt, inflation will ebb and flow as the financial authorities attempt the well-nigh impossible feats of stabilizing prices without crushing the economy and stimulating the economy without causing a resurgence in inflation. Expect to see Jay Powell, Christine Lagarde and other central bankers pivoting like ballerinas as they over-compensate in both directions.
In the case of severe economic dislocation, we may well see another round of money drops – modelled on the Covid response, but dressed up as green transition subsidies or solidarity payments.
As for BoJ Governor Kuroda, he has finally seen his 2% inflation target achieved, although that may not last as the huge rises in energy prices drop out of the calculation next year. Market expectations of Japanese inflation over the next 10 years – as measured by the difference in yields between inflation-protected and regular bonds – are for an annualized rate of a mere 0.84%.
So Kuroda will have an opportunity to run a victory lap before ending his second term in April 2023 – and his successor will be able to celebrate the lowest inflation rate in the G20.