Thursday, May 23, 2013

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% now. 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 gaijin 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, you will understand that the Japanese power structure exists independently of the Occupation-imposed MacArthur 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 mandarins are ultimately captives of the banks. The tradition of amakudari ensures that the mandarins and the banks are always on the same page, and that harmony prevails. This system dates from the gumbatsu coup in 1937.

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 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 in Japan 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”.

Friday Addendum:

May 23, 2013

BOJ Kuroda Says Will Strive to Ensure JGB Market Stability

TOKYO — Bank of Japan Governor Haruhiko Kuroda said on Friday the central bank will make efforts to avert volatility in bond markets through flexible market operations and enhanced communication with market participants.
"We don't have specific targets for stock prices or currency rates, and I won't comment on daily moves," Kuroda said at a seminar in Tokyo.
"As for the bond market, where the BOJ is directly involved in through market operations, stability is extremely desirable," he said.

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