Casting doubt on Japan’s new economic experiment
Almost exactly a decade ago, Ben Bernanke visited Tokyo as a member of the Federal Reserve Board – he was not yet the powerful Fed chairman – and gave some shocking advice to his Japanese counterparts. Surveying the country’s abysmal record of deflation, Bernanke recommended that the Bank of Japan set an explicit inflation target and embark on a massive program of buying government debt to help achieve that goal.
It took a perplexingly long time for the advice to be heeded. Last week, Japan’s new central bank governor, Haruhiko Kuroda, announced that he hoped to achieve 2 percent inflation within two years from the current deflation of -0.70 percent.
To accomplish this, the BOJ will double the size of the money supply to $2.8 trillion in two years by buying long-term government bonds, increasing its balance sheet by 1 percent of gross domestic product a month this year and 1.1 percent next year.
In short, Japan will attempt to do in two years what Bernanke and the Fed have done under their program of quantitative easing in five years. For the cautious Japanese, it was a breathtaking departure from recent practice, which had been constrained by fears that pushing up the inflation rate might bankrupt the BOJ because its large government bond holdings would lose value when interest rates went up.
While these measures are almost universally applauded, it’s an open question whether they will be enough to fix what ails Japan. No two countries are alike, so using a solution that worked well in the United States may prove less than a perfect fit for the Japanese. For example, increasing the money supply is no guarantee that banks will lend and people will start buying consumer goods, the ultimate end of a deflationary liquidity trap. In addition, the Japanese prescription depends in part on the revival of Japan’s export trade – all that monetary easing has led to a sharp decline in the value of the yen, which is supposed to boost the fortunes of companies like Sony and Toyota. But that may prove elusive as long as economies in Europe and the United States struggle with high unemployment.
Kiroda’s appointment as governor of the Bank of Japan was part of a major economic overhaul by Prime Minister Shinzo Abe, who has promised to take dramatic steps to pull Japan out of its funk. In addition to forcing down the yen and increasing the buying of government bonds, Abe has also unveiled plans for a hefty 10.3 trillion yen/$116 billion fiscal stimulus to boost growth in the country.
Although foreign experts like Bernanke and Adam Posen, now president of the Peterson Institute of International Economics, have called for monetary and fiscal stimulus in Japan for many years, what Abe is trying to do is surprisingly similar to the medicine prescribed by Japanese Finance Minister Takahashi Korekiyo in the 1930s: Devalue the yen and embark on a big program of deficit spending and expansion of the money supply. As a result of Korekiyo’s unorthodox approach, Japan was one of the few countries not to suffer in the Great Depression. Korekiyo, often called Japan’s version of British economist John Maynard Keynes, was not so lucky: He was shot by military officers when he proposed cutting defense spending.
There is no disputing that the program adopted by Abe and Kiroda is much bigger and more radical than any economist or foreign exchange trader anticipated. The yen, which was trading at 79 to the dollar when Abe was elected in November, is this week very close to 100, a decline of 24 percent. There was still massive shorting of the Japanese currency by hedge funds, which expect it to go above 100.
Designed to boost exports, the falling yen is already having some repercussions among the country’s trading partners. The Korean won, for example, has fallen from 1,060 to the dollar in mid-January to 1,140 on Monday. Whether the government in Seoul, one of Japan’s major trading rivals, is massaging the currency downwards was not entirely clear.
Perhaps of more concern to the Japanese was criticism from China. Last month, Gao Xiqing, who runs China’s huge sovereign wealth fund, the China Investment Corp., said Japan was using its neighbors as a “garbage bin” by forcing down the value of the yen. Of course, the Chinese have been similarly accused of manipulating their own currency to boost exports, but it remains to be seen if Japan’s action will result in a currency war among exporting nations seeking to gain advantage for their own domestic industries.
Christine Lagarde, the managing director of the International Monetary Fund, gave the Japanese monetary measures the IMF stamp of approval over the weekend while attending a meeting in China. She also warned, however, that “there is a limit to how effectively monetary policy can continue to shoulder the lion’s share” of the effort to boost growth.
That criticism should be heeded in Japan. Increasing the money supply and inflation target is one thing; getting Mrs. Watanabe, the iconic Japanese housewife, to pull her savings out from the Postal Savings Bank and start spending is quite another. As Peter Stella, the former head of monetary and foreign exchange operations at the IMF, remarked recently, increasing bank reserves does not lead to more lending any more automatically than a full tank of gas leads to more driving.
Japan is in what is known to economists as a classic liquidity trap. People are hoarding cash because they expect prices to decline.
The Japanese refer to this as keiki, roughly translated as the economic mood, a phenomenon which is more psychological than financial. How do you get people to spend again after two decades of sitting on their savings?
One way, which Abe has called for, would be to get companies to raise salaries for their employees, perhaps by such measures as lowering corporate taxes. That would give the average salaryman more disposable income, which preferably he would spend rather than save. Unfortunately, corporate Japan has mostly resisted this idea. About 85 percent of companies responding to a monthly Reuters Corporate Survey in February said they would maintain wage levels or cut them in the fiscal year starting in April.
Another issue that could make a difference is increasing the labor participation rate of the Mrs. Watanabes. Japan has improved in the last decade but still lags behind most of the developed world in getting women in the workforce. According to one study, it is just 64 percent in Japan, compared with 83 percent in France and 75 percent in the United States. Another study, by the World Economic Forum, on the gender gap globally, ranks Japan 101st on a list of 135 countries (the United States is 22nd and France is 57th).
Abe’s dramatic prescription for the economy may prove to be the magic solution after many failed attempts. But placing too much dependence on the old notion of reviving export industries at a time when economies in Europe and the United States are still struggling and China is slowing down may not yield the desired result. Japan needs to consume more of what it produces and get more people, especially women, into productive jobs in the labor force. Until then, Abe’s prescription may be only a temporary cure for a very ill patient.
PHOTO: Bank of Japan’s (BOJ) new Governor Haruhiko Kuroda (C) speaks to the media after receiving an appointment letter from Japan’s Prime Minister Shinzo Abe at Abe’s official residence in Tokyo March 21, 2013. REUTERS/Toru Hanai