JAPAN: Game changer
Under its new governor, the Bank of Japan will print money at roughly the same pace as the Fed. Many are uneasy at this prospect
A monetary bombshell, a psychological shock and awe tactic to impress markets, a weapon of mass destruction in currency wars, or simply an anti-deflation gambit? Whichever it was that the Bank of Japan (BoJ) unleashed last month under its new governor Haruhiko Kuroda, the impact reverberated around the world and is likely to continue doing so in coming months.
But while Kuroda certainly stirred things up in global financial markets in early April, the impact that his Y135 trillion ($1.4 trillion) monetary easing strategy will have on Japans long-stagnant and still deflating domestic economy is far from clear. It could prove to be the ultimate Big Bang that wakes Japan up or a damp squib that drowns in liquidity.
Whatever its impact on the domestic economy, some argue that the side-effects on Asia of the BoJs easing and of the Abenomics as prime minister Shinzo Abes economic policies have become known, of which Kurodas initiative forms a part could be profound, via financial and possibly also trade and investment channels.
The World Bank warned in its East Asia and the Pacific Economic Outlook, released after the BoJ move, that Japans decision to join other advanced economies in massive quantitative easing threatens to provoke a surge in capital flows and a series of asset bubbles in Asian and other emerging economies.
The Kuroda package, delivered by the former president of the Asian Development Bank just days after he moved into the hot seat at the Bank of Japan, was the first of what Prime Minister Abe himself in office for just 100 days calls the three arrows of his policy to reinvigorate Japans economy.
Next will come enactment of new fiscal spending in an economy where the ratio of outstanding government debt to GDP is already an astronomic 200%, and then will come a mega deregulation package, including Japans prospective entry into the Trans-Pacific Partnership (TPP) an economic game changer.
The BoJ initiative involves doubling Japans monetary base (to 270 trillion yen) within two years, a pledge to transit from two decades of deflation to a 2% annual increase in consumer prices in the same timeframe, and a major increase in BoJ purchases of Japanese Government Bonds (JGB) as well as other financial securities.
The Kuroda shock pushed the yen down to just short of 100 to the dollar (a four-year low) and the benchmark Nikkei 225 stock average up above the 13,000 mark (a four and a half year high). Japanese Government Bond yields meanwhile oscillated wildly, although they are expected to stabilize in the short term.
The sheer size of the BoJ package which means, for example, that the Japanese central bank will be purchasing government bonds at the same rate as the US Federal Reserve but in an economy one-third in size drew a huge amount of international comment. But it is the possible impact on the rest of Asia that is attracting most attention now.
Near-zero interest rates and new and protracted rounds of quantitative easing in the US, the EU and Japan are inducing large capital inflows into emerging markets including those in East Asia, the World Bank said in its East Asia and Pacific Economic Update released in mid-April. The risk of an asset boom in the markets to which global liquidity spills over is emerging, with asset valuations moving ahead of fundamentals and possibly a correction down the road.
The International Monetary Fund (IMF) added in its latest World Economic Outlook that in Asian and other emerging economies some tightening of policies appears appropriate over the medium term. [This] should begin with monetary policy and be supported with prudential measures as needed to rein in budding excesses in financial sectors.
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Reaction from some in China was swift and sharp. Massive monetary stimulus by the [BoJ] could spell doom for other nations in the region, Tsinghua University professor Li Daokui, a former adviser to the Peoples Bank of China, was quoted as saying, while Liu Ligang of ANZ Bank said that the BoJ action amounted to monetary blackmail and called on Chinese authorities to guard against waves of hot money into China as yen carry trades are reignited.
Quantitative easing is nothing new among major economies, it was Japan that first applied it in the mid-1990s when interest rates approached zero and conventional monetary policy reached its limits but Japans current measures promise to have a broader external impact than monetary easing in the US or in Europe, says Asian Development Bank chief economist Changyong Rhee. Japan is not in a crisis situation as the US or Europe were [when they launched QE], so if they print money now I think there is more of a chance that money will flow out of Japan, Rhee tells Emerging Markets.
Overseas reaction to Kurodas moves was mixed. IMF managing director Christine Lagarde said that the huge monetary stimulus package unleashed by the [BoJ] is a welcome step in supporting growth.
Others, such as George Soros, took a different view. What Japan is doing is actually quite dangerous because they are doing it after 25 years of just simply accumulating deficits and not getting the economy going, Soros said on the sidelines of a conference in Hong Kong. If what they are doing gets something started, they may not be able to stop it. If the yen starts to fall, which it has done, and people in Japan realize that it is liable to continue, and want to put their money abroad, then the fall may become like an avalanche, Soros added.
Since last November, the yen has fallen by around 20% against the dollar while also sliding against the euro and other currencies, as it became clear that Abes LDP was going to sweep the Democratic Party of Japan from power by a landslide.
The yen found it hard to break below 100 to the dollar, however, in the weeks immediately following the Kuroda initiative, apparently because of the yen/dollar buy options triggered at this level. There are lots of options at around 100, but it will eventually break 100, and I would not be surprised to see something like 105 or 110 a month or two months from now, Japans former Mr Yen, Eisuke Sakakibara, tells Emerging Markets. There has been monetary easing in most developed countries, and Japan simply followed the US and Europe, he notes. Japan has no reason to be criticized for doing that. I do not think [yen depreciation] is necessarily negative for other Asian countries. It could be negative but if the Japanese economy grows at 22.5% it would be a plus for the region, and I do think Japan will grow at around 2% this year in real terms.
Markets began buying back the yen in mid-April after the US Treasury, in a semi-annual report, cautioned Japan not to hold down the value of its currency in order to gain competitive advantage in world markets, despite assurances from Abe, Kuroda and Japanese finance minister Taro Aso that the BoJs easing is aimed at ending deflation and not at yen depreciation.
But the yen quickly resumed its downward trajectory after G20 finance ministers meeting in Washington toward the end of April in effect gave the thumbs up to the BoJs easing strategy. Coping with the immediate aftermath of the BoJ package may have been the easy part for Japan. The hard part lies in translating monetary easing into the 23% annual real increase in GDP that Abe is aiming for.
Economic history tells us that loose monetary policy alone will not be enough to increase real activities in the longer run, the ADBs Rhee tells Emerging Markets. The other two pillars of Abenomics (flexible fiscal policy in the short run with fiscal consolidation in the long run and structural reform for restoring competitiveness) have to progress simultaneously.
Abe has made it clear that he is not relying on monetary and fiscal stimulus alone to boost Japans annual GDP growth to the 23% figure he hopes to achieve. He has listed a series of reforms (including greatly boosting womens role in the Japanese workforce) designed to stimulate lagging productivity and to counter the rapid ageing of Japans society. He has also committed Japan to start negotiations for entry into the Trans-Pacific Partnership (TPP), a 12-nation group committed to sweeping deregulation and liberalization of their economies.
Japan has been more or less in recession since 2011, so measures to ease monetary policy and try to stimulate the economy are the right way of doing things, Sakakibara, a former vice finance minister for international relations in Japan, says. However, he adds, I think it is extremely difficult to reach the 2% inflation target because Japan has been in so-called deflation for the past 20 years. It has been [a situation of] price stability. We have not been suffering from traditional deflation which accompanies a recession. Between 2002 and 2007 we had good recovery, and even at that time prices were declining. I am not worried about it, and that is where I differ from Kuroda. Deflation is a structural and not a cyclical phenomenon. Orthodox monetary policy will not solve the problem.
IN THE LONG TERM
Fears about the longer-term impact of the Kuroda package on Japans public debt and on the JGB market meanwhile remain strong. This is equivalent to Japan jumping off a Himalayan cliff without a parachute, or sky-diving without a parachute: its fun until you land, former Goldman Sachs (Asia) vice-president Kenneth Courtis tells Emerging Markets.
I think that they [the BoJ and the Japanese government] have opened the door to very, very substantial risk. They may be able to pull this off, but the path to success is extremely narrow. Its not a path, its a rope, and its going over Niagara Falls, he says. They are basically trying to work on asset price inflation driving up the stock market, driving up real estate prices and bond prices. Extraordinary amounts of money at extraordinary interest rates. Trying to force people to invest in riskier assets.
But this is happening in a context where government debt is likely to hit 250% of GDP by the end of next year, and if Japan achieves its 2% inflation target, the accompanying rise in bond yields and other interest rates could provoke a debt service crisis for the government, Courtis warns.
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