The Enigma Of Japanese Monetary Policy
The Nikkei index fell sharply today. Paul Krugman analyzed the various explanations and concluded that the sell-off was due to a lack of faith in the BoJ’s 2% inflation target. Krugman is correct. Readers will recall that I have never bought into Abenomics and the BoJ’s overnight conversion from deflation-targeting to inflation-targeting. Why? Because the BoJ is a deeply confused and intellectually incoherent organization unable and unwilling to obey its democratically-elected masters.
If you are a monetarist (which Krugman sort of is) you will know that the stock market is about monetary policy and little else (besides creeping marxism, which is what’s wrong with Krugman).
Only someone ignorant of Japan would ever believe that the BoJ will do whatever it takes to achieve 2% inflation on any non-Oriental timeframe. The BoJ is guilty of the twin monetary sins of input-only-focus and dogged incrementalism: “If I turn the hot water faucet by one centimeter a month, I will be able to take a hot shower at some time in the future.”
The BoJ is right on track, Japanese-style, because it is indeed expanding the monetary base; it is turning the hot water faucet at one centimeter a month. The water will someday get hotter. But unfortunately, right now the water is getting colder. Hot shower a few years off.
In Japan today, inflation is not 2%, it is minus 1%, popularly known as deflation. That makes real debt bigger. Despite 23% growth in the Monetary Base, money growth has declined from 3% before QE to 2%. And NGDP (not NGDP growth) continues to decline, an honored Japanese tradition.
I would be interested to know who exactly have been buying up the moribund Japanese stock market, the goldmine of growth stocks. Are they monetarists who believe in the BoJ’s statements? If so, they were uninitiated gai-jin who don’t understand that in Japan there are official statements and understood statements.
If you have read the “Enigma of Japanese Power” by Karel van Wolferen, the only book in English that explains Japan, you will understand that the Japanese power structure exists independently of the Occupation-imposed constitution, and of Western democracy itself. Since the end of military rule, Japan has been ruled by Big Business and Big Finance, which control their respective mandarins (and vice-versa) . The cabinet advises, but the mandarins rule. The BoJ has always been a bit independent of everyone, but it is ultimately a captive of the banks.
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Japanese banks are fatally exposed to JGB prices. If Japanese bond yields returned to terrestrial levels (say 3%), the banks would all be rendered hopelessly insolvent. The banks don’t want that, and the government does not really want it either. Hence, the BoJ is supposed to raise dramatically the rate of inflation without hurting bond prices. Totemo muzukashii desu. “It is a bit difficult.”
Gaijin economists have proposed ways of immunizing the banks from rising bond yields, such as swapping floating-rate bonds for fixed-rate JGBs. These ideas haven’t been discussed because they were proposed in English by American economists “who don’t understand Japan”, such as Ben Bernanke in 2003. “Ah, Professor Bernanke, your speech was very interesting. Is this your first trip to Japan?”
Until Japan can think up a way to protect its banks from 3% bond yields, Abenomics will remain a “difficult challenge that may take a few more years”.