Does the BOJ Now Get It?
As pointed out by FT Alphaville on October 6, something seems to have happened to stir "staid and hesitant" Japanese officialdom over the past couple of weeks, in which the Japanese government and BOJ have, a) intervened in the currency markets for the first time in six years , b) become visibly more active in introducing unconventional monetary policy such as the "extraordinary" JPY5 trillion program to buy financial assets , c) re-introduced ZIRP , d) introduced a JPY4.8 trillion supplementary budget stimulus package for "revitalization" , and e) the un-dusting of an old idea by DPJ lawmakers, which is to create a sovereign wealth fund from Japan's massive USD1.1 trillion of foreign exchange reserves .
After months of insisting that Japan's economy is on a sustainable recovery path, the BOJ seems to have belatedly come around to the idea that there is a real risk of a double dip in Japan's recovery. The BOJ in December 2009 reluctantly adopted a new lending program to provide JPY10 trillion yen of funds for three months at a low rate of 0.1%, and accepting a wide range of collateral.
At an August 30, 2010 policy meeting, the BOJ expanded the program to JPY30 trillion and extended the time period for the loans to six months-before the most recent surprises, which included:
- Launching a "temporary" fund on its balance sheet to purchase up to JPY5 trillion of long-term JGBs, commercial paper, asset-backed commercial paper and corporate bonds, as well as purchase exchange-traded funds and government notes.
- Cutting its key overnight call rate to a range of 0.0%-0.1%, i.e., re-instate ZIRP.
A Case of Self-Induced Paralysis
In a 1999 paper (" Japanese Monetary Policy: A Case of Self-Induced Paralysis ") while still at Princeton, current Fed chairman Ben Bernake laid a good deal of the blame for Japan's 20-year malaise on the shoulders of the Bank of Japan , and on turf wars between the BOJ, the MOF, the later established FSA and successive political administrations. Specifically, the BOJ has been stonewalling for years regarding, a) the introduction of inflation targets, b) taking action to weaken the structural surge in JPY and c) the use of its balance sheet to purchase JGBs/other assets .
After the bursting of the excess credit bubble in Japan in 1990, the BOJ gets exceptionally poor marks for its monetary management. Firstly, monetary policy during 1991-94 was too tight. While the economy to hit rock bottom in 1994, it took another four years for deflation to set in (1998). The BOJ however waited until 1998 to introduce ZIRP (zero interest rate policy)-by which time the economy was so depressed even zero rates could not revive it.
Further, the BOJ waited until 2003 to sharply increase purchases of financial assets to expand money supply ((QE)). Moreover, it prematurely raised interest rates in 2006 on the mistaken belief that the economy had reached sustainable recovery. During this period, BOJ monetary policy wavered between different policies, and the Bank acted only reluctantly in stepping outside the box to introduce QE, because they didn't believe it would work.
Further, BOJ stonewalling was particularly pronounced on the subject of the strong yen . Foreign economists (Metzer, McCallum, Bernanke) have been recommending since 1999 that the BOJ should attempt to achieve a substantial depreciation of JPY . The BOJ continues to argue that it does not have the legal authority to set JPY policy, would be unable to influence JPY's value in any case, and that even if it could reduce the value of the yen, political constraints prevented any significant depreciation.
Damningly, Mr. Bernanke in 1999 flatly stated that BOJ officials " have hidden behind minor institutional or technical difficulties in order to avoid taking action "-a statement which we believe is still valid today. Mr. Bernanke pointed out in his 1999 paper that "I am not aware of any previous historical episode, including the periods of very low interest rates of the 1930s, in which a central bank has been unable to devalue its currency". In other words, Japan (the BOJ) could devalue JPY if it really wanted to.
Finally, Mr. Bernanke in 1999 noted another perennial BOJ problem, which is the vagueness of BOJ policy . Mr. Bernanke was entirely right in pointing out that the BOJ's credibility would actually be enhanced by engaging in straightforward and honest dialogue with the public and particularly investors.
This vagueness of policy (lack of communication with the government and the public), reluctance to act to weaken the yen, introduce inflation targeting and aggressively use its balance sheet has Japanese politicians mounting the most serious challenge yet to its jealously guarded independence since it was granted in 1998, and has severely damaged its precious "credibility" with foreign investors.
Further, in granting the BOJ its independence in 1998, the government also gave the BOJ a mandate, which was to ensure price stability. This of course includes periods of deflation as well as inflation, and that's the rub, because the BOJ has so far failed in its efforts to eradicate deflation.
No Choice but to Play the Revaluation/Devaluation Game
While the BOJ's elitists view the political machinations of Nagata-cho with barely concealed distain and therefore tend to sniff disapprovingly at any pressure from the government to act, the BOJ basically has no choice but to play the global "race to the bottom", as essentially every government in the developed world is trying to reflate its economy by flooding it with liquidity, pushing down bond yields, and deflating the currency. Withdrawing from the game or acting too slowly runs the risk of a new historical high in JPY/USD below JPY/USD 79 or maybe even 50, and domestic investors expect the BOJ to eventually increase annual purchases of JGBs to at least JPY35 trillion from JPY21.6 trillion yen currently.
A little mentioned factoid is that the BOJ's balance sheet in relation to Japan's GDP is already larger than the Fed's balance sheet to the US GDP, at 26% versus 16%--but that's not the point, which is the consensus that the BOJ needs to foster inflation not only by more aggressively using its balance sheet but also by setting a specific inflation target of 2%.
After two lost decades in Japan's economy through monetary mismanagement, among others, has the BOJ really changed its stripes? Call me from Missouri--you've got to show me first , as the image implanted in investor minds is of a Fed clearly stating "we will do whatever it takes", and of a BOJ sitting on its hands and intellectualizing why it can't be done.
Disclosure: No positions in [[EWJ]] or [[FXY]]
See also Dollar's Fate Is in the Hands of the S&P 500 (Again) on seekingalpha.com
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