A time of unqualified promises

April 2, 2013

By James Saft

(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 Asia.


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, Reuters columnist 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. For previous columns by James Saft, click on)

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