Wednesday, April 10, 2013

On “Abenomics” Step One, on China Radio International

This Monday, I took part in a one-hour panel discussion on China Radio International entitled “Japan’s Central Bank Reviving the Economy.” Some people have questioned the wisdom of appearing on a Chinese state radio, but I've never been censored or told what to say. (I've managed to say “Senkaku Islands” twice in a 5-minute interview.) Until something like that happens, I'll keep obliging them. The following is my crib sheet, whose answers I'd whacked out the day before with a little help from Jim Beams, then slightly revised the next morning. I changed my mind on at least one point after a comment from Professor Robert Dekle—it may be noticeable in the podcast—but I've left the memo as it was.


2013.04.08- Japan’s Central Bank Reviving the Economy- DRAFT QUESTIONS
PART 1 (10:05-10:20)- Understanding Japan’s Economy
OVERVIEW (Brief Opening Positions)
1 Do you generally support Japan’s hyper easing policy or are you against it?

I support it. The Japanese economy has been underperforming over most of the last couple of decades, the chronic deflationary environment is a major reason why, and there are enough experts convinced that hyper-easing is at least a good place to start.

2 How would you describe Japan’s economy today?

Chronic underachievement. World class workforce, world class infrastructure, and world class manufacturers somehow add up to economic disappointment.

3 What are main factors that have hurt Japan's economy for years?

The failure to:
1) 1990s failure to deal with the consequences of the collapse of the bubble economy.
2 face down vested interests in the policy-making process
3) synchronize labor law and the social safety net
4) optimize the utilization of women in the workforce. (This appears to be an East Asian, not Japanese, failure.)

4 What is behind decades of deflation?

First, interest rates have fallen globally since the 1990s. When is that last time any state other than a few failed states had to worry about hyperinflation? And it's been only a little over a dozen years since a deflationary environment became the norm, not an exception. Beyond that, though, Japan does suffers from a chronic consumption and investment deficit, which appears to have created a self-perpetuating deflationary environment. Abe, in his own way, is aware of that, and is pushing an economic program to reverse this.

5 The classic description of Japan’s economy has been the aging population slowing growth, is this really that hurtful? At the same time as the population aged Japan also seemed to top out of infrastructure projects and faced substantial competition from regional powers South Korea and then eventually China, is Japan really a victim to domestic aging or regional competition?

The problem is the combination of a declining working-age population and a rising elderly, non-working population. The Japanese economy has a harder time raising productivity even as social expenditures grow.

Chinese and South Korean competition has been painful for Japanese construction firms, but Japanese engineering firms, for one, have more than held their own against global competition, while the manufacturing sectors are to a great extent mutually compatible and reinforcing. Besides, the reliance of the Japanese economy on exports has always been surprisingly low.

6 Japan’s domestic investment has slowed substantially. Some say this is because private companies have moved manufacturing and capital intensive investment to other countries because of strict environmental rules. How much has regulation pushed this investment out of Japan?

I believe that offshoring is mainly driven by cost considerations and the need for presence in growing markets. Sometimes, local content rules give manufacturers no choice. Regulatory costs certainly enter into the equation, but they are not as big a factor as you might imagine. Developing countries and emerging economies have quite stringent environmental rules and regulations, and Japanese firms established there follow them religiously, if only because they have too much reputation at risk and too little political leverage to avoid the consequences of violations.

7 The Japanese government has engaged in various capital intensive infrastructure projects. Why have they failed to stimulate the economy long term?

There is reason to believe that a good portion of those infrastructure projects turned out to be poor investments in terms of raising productivity. To give an example: Work on Narita International Airport languished for decades while the more convenient Haneda Airport was kept out of the regular international flights market. The result: Japan slips behind in the battle of the Asian hubs while it is left with small, money-losing airports scattered all over Japan.  

8 Japan's modern economy is built on incredibly low interest rates, aggressive asset purchases by the central bank and the world's 2nd largest national debt, how successful has this monetary policy been?

Interest rates look much higher if you factor in deflation, and a negative nominal interest rate is difficult to engineer. By comparison, Chinese state enterprises and national flagship companies can borrow under negative real interest rates. That's why Prime Minister Abe and Governor Haruhiko Kuroda are taking aim at a 2% inflation target, and replacing interest rates with the monetary base as the focus of monetary policy. That means buying loads of Japanese Government Bonds (JGBs).

9 Japan has been the classic example of a “liquidity trap” for years, is the answer to that problem even more liquidity?

Kuroda calls it quantitative and qualitative easing. The Bank of Japan is attempting to generate inflationary expectations while keeping long-term interest rates low by going long on maturity in its JGB purchases. It's also increasing its exchange-traded fund and real estate fund purchases. The hope, expectation, is that this generates a virtuous cycle out of the liquidity trap.
PART 2 (10:20-10:32)- BOJ Plan
10 The new BOJ plan fits exactly with Shinzo Abe’s hyper easing campaign promises. He also forced his way into choosing a new BOJ governor. Is the BOJ losing its independence? Is that going to undermine its impact on the economy?

Remember that most governments have the right to choose their central bank governors contingent on legislative consent. Once in place, those governors enjoy great independence throughout their terms. Japan is no different. And in terms of policy coherence at least, it is a good thing to have the administration and the central bank sin broad agreement on policy goals and the means to achieve them.

11 Japanese central bank governor Haruhiko Kuroda is planning to inject 1.4 trillion US Dollars into the economy to spur inflation and revive growth. What is he trying to achieve with this?

You are referring to the doubling of the monetary monetary base, which is part of the policy package designed to achieve a 2% inflation target in two years' time while keeping interest rates low. The idea is that low nominal long-term borrowing costs under inflationary expectations will provide a pro-investment environment for businesses and households.

12 What are risks involved in such kind of massive bond sales on the government's debt?

The perception that the BOJ is financing an ever-growing public debt could touch off a massive JGB sell-off, the bond market collapses, interest rates go through the roof, and hyperinflation ensues. This is a low-probability scenario, but the Japanese government does have to restore credibility in the long-term sustainability of the public debt, or that scenario will gain more credibility, with serious consequences all around. That's why the fiscal part of the Abenomics package cannot begin and end with spend-spend-spend and the long-term growth strategy must have real teeth.

13 This is twice the size of the US quantitative easing. Why is the stimulus so radical this time? Did Japan need to shock the markets to continue to push its currency down? Did the long build up to this announcement require the BOJ to go bigger than it wanted to?

With expectations already baked into the equity and currency markets, Kuroda needed to do something dramatic and unexpected, at least at this juncture so early into his regime. “Doubling down” seems to be a good way to send a clear, if not quantitatively explainable message. I also think that Kuroda wanted to signal a clear break with the past with a Big Bang approach. Who knows what would have happened if the BOJ had taken a more measured approach? I suspect that it would have eventually wound up doing more cumulative easing to less effect.

14 The governor of the BOJ says the plan will double the nation’s monetary base to 3 trillion US Dollars by 2014, what does this mean?

Most of the increase will come in the form of current deposits held by banks in BOJ accounts. The expectation is that this, coupled with the purchase of JGBs with longer maturities and other elements of the policy package, will help boost investment.

15 The BOJ will be the only major central bank to target Monetary base, how different is this type of target? Should banks be focusing their goals on monetary base?

The Japanese economy is unique in that it is in a chronic deflationary environment. With interest rates effectively bottomed out at zero, the BOJ appears to have no choice but to look to the monetary base for policy guidance. At least that's how I see it.

16 Is setting a target to increase inflation healthy for a central bank? Growth numbers driven by inflation can be misleading, is Japan trying to pump up its numerical growth rather than real growth?

It is healthy when you have chronic deflation, and inflation in the vicinity of 2% looks like a reasonable premise for a functional monetary policy. Real growth, of course, is the ultimate objective, but the Japanese economy is underachieving, and chronic deflationary expectations appear to be a significant cause of this.

17 Some analysts say Japan already has inflation. They say that looking only at CPI is misleading, but if you look at credit on the market there is already an overabundance of credit. Are these inflation targets looking at credit or simply at CPI? With so much credit inflation on the market already is there any guarantee that even more would finally hit CPI?

There is no “credit inflation” unless the price of goods and services goes up, no? And that is exactly what the inflation target and the policy package are intended to achieve. Yes, there is plenty of money out there; it simply hasn't translated into rising prices. Let's hope that Governor Kuroda's clear-cut, Big Bang approach works.

18 Some analysts say an aggressive inflation target like this only works if you can convince people to buy ahead of prices rising, is that really true? Is the potential inflation going to spur near term buying?

The idea is that inflationary expectations will spur buying, in terms of investment and consumption. I am aware that the 2001-2006 quantitative easing did not achieve that kind of result. So there is a risk that the issue will remain unresolved over the course of Governor Kuroda's term, which would be a major problem for monetary policy precisely because he has taken a Big Bang approach and has no additional tools to call on.

19 If you don’t get this psychological/economic response are inflation targets going to backfire on Japan?

Yes. Everything goes back to square one, except the BOJ will have a lot of JGBs on its hands. Worst case scenario (see 12) becomes more plausible.

PART 3 (10:32-10:47)- Impacts
20 Is the new BOJ policy currency manipulation?

A floating currency rates means that anything significant that happens in the domestic economy directly affects the exchange rate. In that sense, all governments are currency manipulators. If it were my choice to make, I would have governments talk to each other about the negative effects, real and potential, of exchange rate controls and currency market interventions without using what is actually a US legislative concept.

21 Tokyo is already under fire in the US, accused by some of currency manipulation. Is Japan going to set off a currency war with this new plan?

No. As long as the Japanese government or the BOJ does not start buying up foreign currency-denominated financial instruments, this will not become a significant political problem.

22 Will other countries follow Japan by engaging in quantitative easing? Or will the ones who can control their currencies more directly artificially weaken their currencies?

The US and Europe are already doing it, no? Countries like China exercise more direct control on exchange rates, which has its own merits. But exchange rate controls are a more brittle regime; the harder they come, the harder they fall.

23 Some are of the opinion that this will achieve its aims, helping to boost consumer prices, drive up domestic demand and help spur growth. But others say given the sluggish state of the Japanese economy, as well as problems in Japan's key export markets, business and consumers are not too keen to borrow money at this stage. In this case, all this extra cash is likely to sit with the banks and not flow to the real economy. So is there a risk that benefits will not flow into the real economy?

If the real economy fails to pick up, then yes, there is a risk. But the global environment appears to be picking, if modestly. And the Japanese economy is far less reliant, always has been, on exports than, say, China and South Korea. Public sentiment has taken a turn for the better, and the employment picture for new graduates has been improving for the last two fiscal years.

24 Will banks begin to engage in “Currency Carry Trade” rather than truly invest in the economy?

The yen has already fallen significantly. I don't think that Japanese banks are ready to go back to the zaitech of the nineties any time too soon.

25 It's not just the volume of new money that is significant; it is where the new money will go. Kuroda is targeting long-term government bonds and non-government assets such as ETFs - Exchange Traded Funds. Buying ETFs is a way for the central bank to push money directly into the stock market, supporting and increasing the value of assets. Will the inclusion of ETFs simply push money into the stock market? The US stock market has been booming yet the impact on jobs is significantly less. Is Japan getting caught in the same trap of focusing on the stock market rather than the real economy?

Not very much. The amount of ETF purchases is relatively modest—the ETF market is relatively small—and there are signs that rising stock prices are already boosting luxury goods purchases. Anything that raises consumption is useful in the current economic environment. Rising stock prices also helps financial institutions and encourages businesses to raise funds through the equity market.

26 At 230% of the GDP, Japan's public debt is already the highest among industrialized nations. How will such stimulus move impact Japan's national debt?

Keeping interest rates down helps keep debt service down while rising GDP and inflation increase tax revenue, don't they? This in turn diminishes the need for deficit bond issues, or at least that's how the logic goes.

27 Is japan actively trying to monetize its debt? Considering the large amount of Japanese bond holders are Japanese, is this that concerning?

No, as long as the BOJ is conducting monetary policy of its own volition and is not being forced by the government to buy those JGBs.

28 Some say in a worst case scenario, the government may not have enough cash to make those payments and will be forced to sell additional bonds to raise money. How bad would that be?

The Japanese government already issues deficit bonds, which is essentially “not having enough cash to make those payments and will be forced to sell additional bonds to raise money.”

29 If the BOJ will be buying 70 percent of the bonds available monthly with this program, wouldn’t that mean market appetite for bonds would still remain? Wouldn’t that mean even if the government has to issue extra bonds to roll over debt, they would have willing customers?

Yes. As long as financial institutions and institutional investors think believe that the bond market will not collapse.

PART 4 (10:48-10:58)- Next Steps
30 The Abe government has already announced aggressive fiscal spending. How will this monetary easing policy interact with this new spending? Is all of this too much stimulus?

The LDP touted a 10 year, 200 trillion yen public investment program coming in. I suspect that this is more bark than bite and will be quietly scaled back as the overall Abenomics fiscal strategy comes under closer scrutiny.

31 What should the BOJ do next?

Nothing, except stay the course. Unless there is a significant change in the economic circumstances. In poker terms, the BOJ went all-in. It's the Big Bang approach. To change course now, even in a benign direction, would seriously undermine credibility in the Kuroda regime.

32 What should the Abe Government do next to help the economy?

Two things: a credible long-term plan to sustain fiscal credibility, and a credible long-term growth strategy that overrides entrenched vested interests. Prime Minister has three months to convince the Japanese public, before the July upper house election.

33 If you were a business person in japan, how would you be reacting to these actions?

I'm not a businessman, never have been. But I can tell you that business response has been generally favorable. That said, businesses reliant on the domestic market and imported inputs are rightfully worried about rising costs while they wait for the consumption tax hike to kick in less than a year from now.

34 What should regional national competitors do in response to these policies?

Maintain a sense of proportion. Japan is an important part of the regional economic environment, and the falling yen has a negative effect on the Japanese import environment. But there's more to their export environment than Japan, the yen will rise again if Abenomics works, while inflation will eventually work against the competitivity of Japanese products, and Japanese achievement of its full growth potential surely benefits all regional economies.

35 Will Abenomics, a combination of big government spending as well as an aggressive central bank asset buying program, work to push Japan out of deflation and stimulate its growth?

My answer to this kind of question is always the same: I'm an optimist; I have to be, I live here. And then there's the third arrow in his quiver: the long-term growth strategy.

36 Will Abenomics be harmful to regional economic cohesion?

A strong Japanese economy is good for the regional economy. Remember, Japan is a major customer of Chinese and South Korean goods and services. 

Thursday, April 04, 2013

Kuroda Swings, Clears the Bases

BOJ Governor Haruhiko Kuroda got essentially what he (the market too) was asking for, by way of mostly unanimous decisions to boot (the announcement in English, here). Am I surprised? Yes. The two dissents, both by one board member, were a little too arcane for me; in any case, they appear to have little practical consequence. Now, Kuroda owns it. And many, perhaps most, experts believe that the 2% target will be hard to achieve, especially within the informal two-year window that the Kuroda team has situated for itself.

One government observer said to me that it won’t be such a big deal two years from now one way or the other. True—if the other economic indices, real GDP, jobs, etc., are in good shape and public sentiment is robust. But if the broader economic outcome is ambiguous, Deputy Governor Kikuo Iwata will have provided critics a big stick to beat the Kuroda team with by putting his job on the line with regard to that two-year timeline at the confirmation hearings. I think that Iwata went out of bounds by drawing his own red line, when Kuroda had not committed himself nearly that firmly.

My Expectations for the Day at the Bank of Japan

Later in the day, the BOJ Policy Board will wind up two days of deliberations by announcing changes in monetary policy aimed at achieving the 2% inflation target in two years. Consolidating BOJ’s asset purchase program with its regular, so-called Rinban, operations seems like one of the easier things on which to achieve a nine-member consensus, though the technical details may take a little longer to work out. Governor Haruhiko Kuroda would no doubt like to secure majority support for all the other four items that have been aired in public, and he could all but erase market uncertainty by bringing all of them to a vote today. However, my guess is that he will only have the board vote on the items for which he has secured a majority and present them outcome as the first stage in a measured rollout process. He cannot afford to have anything voted down so early in his regime, can he?