A time of unqualified promises: James Saft

April 2, 2013

April 2 (Reuters) – Just as Mario Draghi’s pledge to “do
whatever it takes” to preserve the euro is being challenged, the
very same unqualified promise, this time to simply stop prices
falling, is about to be put into action in Japan.

In both cases within months we may well discover if it is
the promises or the problems which are without limits.

In Japan, newly appointed Bank of Japan Governor Haruhiko
Kuroda will on Wednesday convene a two-day policy meeting, his
first after assuming office and pledging to do – again those
words – “whatever it takes” to end years of deflation.

While Kuroda’s supporters would probably stress that
“whatever it takes” is in this instance a process rather than an
event, the BOJ is widely expected to take radical new steps in
its quest to achieve a 2 percent inflation target within two
years. Media have reported the central bank intends to move to
begin “open-ended” bond purchases directly rather than in 2014,
as well as to start buying longer-term bonds and possibly
expanding the range and scope of purchases of other assets such
as equities.

Open-ended, at least in this context, means that the central
bank will buy bonds until its goal is achieved, but the promise
is likely to be rather thin on the issue of exactly how it will
ratchet up its actions as the months pass and, as may well be,
prices stubbornly refuse to rise.

So far Kuroda, and Prime Minister Shinzo Abe, have been very
successful in convincing one constituency – investors – that
they mean business. Tokyo shares have risen sharply and
better yet the yen has fallen against the dollar,
improving the global competitiveness of Japanese exports.

Even Japanese consumers seem to be putting faith in the idea
that a determined central bank with a printing press can cause
prices to rise. A quarterly survey of consumers by the BOJ
released on Monday showed that nearly three quarters expect
prices to rise in a year’s time, though only 9.5 percent
expected their own income to also go up.

That raises a somewhat ironic possibility. A sensible
household, and Japanese households do seem sober in their
approach to personal finances, might react to the prospect of
higher prices and stagnant incomes by deferring purchases and
cutting back on luxuries, thereby causing the very deflation the
threat, or promise, of inflation is supposed to end.

Companies in Japan too are less deflation-minded than
recently, with fewer expecting prices to fall, though more
seeing downward than upward pressure overall. A key test for the
BOJ will be whether it can spur the kind of investment by
companies that might start a virtuous cycle of rising incomes
and consumer spending.

One problem is that Japan exists in a context, rather than a
bubble, and its own particular context includes sagging demand
from Europe and fierce competition from exporters elsewhere in


This rash of new activity by the BOJ is in interesting
contrast to Draghi’s European Central Bank, which has had, or
rather has chosen, to do surprisingly little in the months after
his July promise to preserve the euro, even as the
situation in Cyprus has sharply deteriorated and promises to
slide yet further.

Cyprus has imposed capital controls to limit the flight of
funds out of its financial system and clipped large depositors
in its worst banks by as much as 60 percent. The ECB has its own
interest-rate policy announcement on Thursday and there is some
speculation that it may ease rates, a move that would be fully
justified by low inflation and weak economic data in the
currency union.

Forcing Cyprus to knuckle under and bail in depositors – a
move which marks the effective end of its off-shore banking
industry – is in some ways a success for the ECB, which can say
it is not on the hook to all banking systems in an unlimited
way. But it has also brought about, on a small scale, that which
Draghi pledged to avoid.

The euro has already – kind of, sort of – broken up, in that
a euro on deposit in a Cyprus bank is most surely not worth as
much as one in Germany or one fallen behind someone’s couch
cushions in France. A currency union with internal capital
controls isn’t much of a union, and for Cyprus may not be
something it wants to stay in. Its economy will shrink and it
won’t be able to devalue its currency to suit its plight.

In both cases, Japan and Europe, promising to do “whatever
it takes” will prove a powerful tool, but a bit of a wasting
asset. The longer we go, the less believed it may well be.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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