Published in the Nikkei Asian Review November 1st 2016
“The Bank of Japan has admitted defeat,” says the feisty former TV journalist who recently took over the helm of the Democratic Party, Japan’s largest opposition grouping. Renho – she goes by just one name – went on to state that “what is needed is a total reappraisal of Abenomics.”
The grounds for her critique were the new measures that Governor Haruhiko Kuroda announced at the BoJ’s September meeting and confirmed at the subsequent meeting on November 1st . The BoJ has committed to fixing the yield on 10 year government bonds around the prevailing level of 0% while allowing the yields on “super-long” bonds with maturities of over 10 years to rise.
This “yield curve control” offers some relief to income-hungry institutions such as insurance companies, but means that the BoJ’s previous plan to buy 80 trillion yen of bonds per year is no longer set in stone. How much of anything you need to buy in order to hit a price target cannot be decided in advance. It all depends on the behaviour of the sellers.
It was not only opposition politicians who sensed a weakening of the BoJ’s resolve. Former BoJ board member Sayuri Shirai termed the new approach “an implicit tapering” and went on to say “this is clearly a tightening of monetary policy.”
SUMO CHAMPS DON’T DIET
So is Kuroda taking his foot off the accelerator at time when Japanese consumption is subdued and inflation miles away from the official 2% target? That would seem a strange decision given his still bullish comments on the prospects for successful reflation. And as Renho’s remarks make crystal-clear, there would be substantial political blowback for the man who appointed him, Prime Minister Shinzo Abe. Expansionary monetary policy is the very core of Abenomics; Kuroda signing off on a tightening would be like a sumo champion going on a vegan diet.
There is another interpretation, which is the complete opposite of the above. By pegging the long-term rate at zero, Kuroda is opening up the possibility of a dramatic acceleration of the reflationary dynamic. On his blog former Governor of the Federal Reserve Ben Bernanke commented on the BoJ move as follows –
“In defending a peg, a central bank gives up control over the size of its balance sheet, committing to buy whatever supply of bonds is forthcoming at the target rate. In the extreme case, a central bank trying to hold down yields could find itself owning most or all of the eligible securities” (my emphasis).
For now that seems like an unlikely prospect. The standard complaint is that there is not enough liquidity in the bond market. In other words, despite Japan’s Godzilla-sized stock of public debt, investors are refusing to dump their bond holdings even at the lowest yields – and therefore the highest prices – in human history.
If this remains the case, then Renho and Sayuri Shirai will be right – “yield curve control” will be a form of tapering. In a deflationary environment with chronic financial instability, it is conceivable that government bond yields would fall below zero even with greatly reduced asset purchases by the central bank.
What happens, though, if interest rates rise on a global basis? Then the commitment to cap 10 year yields at zero would surely lead to significant weakness in the yen. As investors began to believe that the cap would be lifted at some point – perhaps, as the declining yen began to stoke inflationary concerns – they would rush to sell their bonds to the central bank in order to avoid a certain capital loss. If the selling snowballed, the BoJ might end up, as Bernanke hypothesizes, monetizing the entire stock of Japanese government debt!
These are both extreme scenarios. The 0% commitment is provisional, like all central bank pronouncements these days. Yet it remains the case that the BoJ’s new initiative significantly increases Japan’s leverage to the global deflation/ inflation cycle.
AUSTERITY NO LONGER COOL
That cycle will turn in due course because the political cycle has already turned. The combination of loose monetary policy and fiscal austerity has not delivered the anticipated economic benefits and across the developed world mainstream politicians are running scared of populists.
Meanwhile, the collapse of interest rates almost everywhere has invalidated fears that a large stock of public debt would inevitably lead to a fiscal train-wreck. No surprise, then, that austerity is rapidly going out of fashion, as demonstrated by the expansionary fiscal proposals of both American presidential candidates.
Expert opinion has shifted too. According to Catherine Mann, the OECD’s chief economist, monetary policy “has been used alone for too long…. fiscal policy must be deployed more extensively.” The IMF, once the bastion of fiscal discipline, is singing from the same hymn-book. Larry Summers, who could be influential on a future Hillary Clinton administration, is recommending infrastructure spending worth 1% of US GDP for the next 10 years. In the UK Stephen King, chief economic advisor to HSBC, suggests the Bank of England should directly finance a “gilt purchase fund” to be disbursed on tax cuts and / or infrastructure spending.
King admits that his proposal amounts to “helicopter money,” as famed economist Milton Friedman called the injection of newly created money directly into the economy. Kuroda rejects the term at every opportunity. Instead the BoJ’s September statement made vague reference to “synergy effects” between monetary and fiscal policy, as the government steps up its public works program. As Bernanke noted drily in his blog, “what constitutes helicopter money is a semantic debate, but a policy of keeping the government’s borrowing rate at zero indefinitely has some elements of monetary finance.”
ABENOMICS THROUGH TO 2021
It has become increasingly likely that Shinzo Abe will become the longest-serving prime minister in Japanese history. The governing Liberal Democratic Party is about to change its rules and allow him a third term in office, which could keep him in the job until 2021. Team Abe are unlikely to give up their signature policy of reflating the Japanese economy. Indeed, frontal attacks by political opponents like Renho will give the issue greater urgency.
So far, Kuroda and other central bankers have conducted quantitative easing programs that are massive in scale, yet conservative in content. The focus has been on purchasing government bonds from the banking system, which has parked the money received back at the central bank in the form of reserves. Very little has leaked out into the real economy, which is why inflation has yet to rear its head. With the adoption of more aggressive fiscal policy, that is about to change.
If you listen closely, you might hear the whirring of helicopter blades – and not just in the skies of Japan.