In the battle for top spot in the Economics Premier League, Monetarist United has pulled well ahead of big-spending Keynes City and the hard men of Vienna F.C. That is the message from Japan, where the reflationary policies associated with Prime Minister Abe are producing results much faster than expected. Workers and job-seekers are benefitting, but the effect on the stock market is ambiguous.
From the dawn of Abenomics, the nay-sayers and doomsters were out in force, offering a variety of reasons why it could never work. According to former governor of the Bank of Japan, Masaaki Shirakawa, deflation in Japan was demographic in origin and therefore pre-destined. According to bearish macro traders, apocalypse in the Japanese bond market was a matter of months away.
The general consensus was that “money-printing” on its own would accomplish little. Without “third arrow” structural reforms, the whole project would fall flat on its face.
Amidst all the pessimism, one eminent economist called it right, even though he’d been dead for several years. As long ago as 1997, Milton Friedman offered the following prescription to Japanese policy-makers –
“The surest road to an economic recovery … is to shift from tight money to easy money, to a rate of monetary growth closer to that which prevailed in the golden 1980s, but without again overdoing it… There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so… A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.”
It took an awfully long time, but Friedman would be happy to know that his advice was eventually heeded. He would also have been interested in conditions across the East China Sea. Even the leadership in Beijing now admits that the gargantuan program of Keynesian stimulus undertaken after the global financial crisis of 2008 was a serious mistake that has left the financial system sagging under the burden of bad debts.
Economists of the Austrian school, which emphasizes the importance of credit bubbles and mal-investment, have a better record in explaining the post-2008 world, with its over-leveraged consumers and corporate cash hoards. Yet they offer little in the way of policy response and underestimate another key lesson of the Japanese experience – the extent to which even healthy investments go bad under protracted deflation.
Friedman’s monetarist approach to deflation was first implemented by the Federal Reserve under Ben Bernanke and Mervyn King’s Bank of England. It has the virtue of providing radical, market moving prescriptions, which are reinforced by adroit messaging about future actions.
One problem, though, is the difficulty of quantifying the effect – even in retrospect. Martin Weale, an external member of the Bank of England’s Monetary Policy Committee, recently estimated the impact of the UK’s first round of quantitative easing, which took place in 2009, at almost 7% of nominal GDP. Previous estimates by reputable academics had been less than half that.
It is hard for anyone, the Bank of Japan included, to know how much monetary stimulus Japan needs. So far cautious private sector economists have been surprised by the rapidity of the rise in actual and expected inflation. Since Prime Minister Abe took office at the end of 2012, inflationary expectations as derived from bond yields have increased by 1.6% and the rate of change in consumer prices by 1.5%. On that basis, the BoJ is already most of the way to its 2% target.
More help comes from the tight labour market, which is starting to roll back the long slump in wages. Forward-looking employers are already attempting to lock in human resources; Fast Retailing, the company behind the Uniqlo brand, recently announced that it would offer permanent jobs to sixteen thousand part-time staff. The era of casualization, which benefitted slack managements at the expense of young workers trying to build a career, has passed its peak.
In the US and the UK, more than five years of unprecedented monetary stimulus has succeeded in bringing inflationary expectations back to the average levels of the early noughties. The thinking had been had been that Japan would need a similar length of time to reach the BoJ’s goal. The financial markets were pencilling in a second round of measures (“JQE2”) for this summer and the distinct possibility of “JQE3” in 2015. Thanks to the inflation surprises, that assumption is now open to question.
Abenomics working better than expected is good news for consumption, for workers and job-seekers and obviously for Mr. Abe himself. For the stock market, however, the news is more ambiguous. In the US, it was the announcement of QE programs that triggered the fiercest rallies in the S&P Index. Likewise, the BoJ’s aggressive easing made 2013 the best year for the Topix Index since 1973. Momentum investors and speculators will be sorely disappointed if there are no new initiatives on the horizon.
Longer-term, though, that would surely be a healthy development. A market supported by fundamentals rather than ever-greater injections of liquidity might be duller, but should provide a steadier and more sustainable source of return. With Japanese stocks valued at the lowest price-to-earnings ratio since 1970, patience should ultimately be rewarded – even with no further contribution from the maestros of Monetarist United.