Japan’s lessons explain Fed’s plight
If there’s anyone who feels Janet Yellen’s pain, it’s Japan’s Toshihiko Fukui.
After four interest rate hikes since December 2015, Federal Reserve Chair Yellen is suddenly throttling back. Recently, she admitted there’s “uncertainty about when—and how much—inflation will respond to tightening resource utilization”. The Fed’s conundrum: why unemployment around 4% and record stock prices aren’t fueling inflation. The upshot is fewer rate hikes as Yellen and Co. probes what’s wrong.
That gets us back to Fukui, who ran the Bank of Japan (BoJ) from 2003 to 2008. Fukui grabbed the reins from Masaru Hayami, who pioneered quantitative easing. Hayami first cut rates to zero in 1999 and then forged into the unknown with unprecedented asset purchases to flood the economy with yen. Fukui, who’d spent decades at the BoJ, took the governorship determined to normalize Tokyo’s monetary environment.
At first, he left the punchbowl out—even replenishing it at times. Early on, Fukui grappled with Japan’s fourth recession in 12 years and deepening deflation. By March 2006, things appeared buoyant enough to end quantitative easing (QE) and enter a bond tapering phase. By July of that year, the BoJ raised rates—by 0.25%—for the first time since August 2000. Fukui pulled off another hike in February 2007, putting the overnight lending rate at 0.50%.
Then the real drama began.
The Nikkei 225 Stock Average plunged below 15,000, the political and business communities went ballistic, economists quaked and an ensuing sense of panic scuttled the recovery. When Fukui left the BoJ in 2008, the first act by his successor was returning rates to zero. And the current BoJ chief, Haruhiko Kuroda, took QE to entirely new dimensions. These same challenges, pressures and conundrums are now Yellen’s to juggle.
Yellen is to Fukui what Ben Bernanke was to Hayami. Former Fed chairman Bernanke’s QE was emergency triage to save a coding patient. It was never meant to be a permanent fixture. Just as the BoJ turned Japan Inc. into a $5 trillion junkie, Bernanke’s largesse hooked bankers, corporate executives and investors. More than just a vice, free money has become an entitlement that the entire system, consciously or not, tries to preserve. It now falls on Yellen to wean a giant economy off the financial equivalent of a drug addiction—to devise a 12-step programme that gets the US clean and healthy.
But Yellen is at the same fork in the road that confronted the BoJ a decade ago: is it better to bow to anxious markets and obtuse politicians or administer tough medicine needed to cleanse the system?
It’s a common dilemma these days. What Europe’s Mario Draghi, Britain’s Mark Carney, Canada’s Stephen Poloz, South Korea’s Lee Ju-yeol and, of course, India’s Urjit Patel have in common is a tug of war with markets angling for more help from central bankers.
In Yellen’s case, consumer prices remain essentially flat amid tepid retail sales and milquetoast business confidence. But the Fed has had 590 days to gauge the fallout from its first hike, and the three since then. And surely it sees how compulsively engaged bankers, companies, politicians and traders are with central bank stimulus—living monetary hit to hit. Fear of sobriety, of responsibility, is having a collective, chilling effect on growth, business dealing and financial transacting.
As Warren Buffett famously observed, “only when the tide goes out do you discover who’s been swimming naked”. When borrowing costs disappear, huge public debt loads seem manageable. Bad loans on bank balance sheets appear less dire. Overcapacity across industries and shrinking market share look less ominous.
When the monetary tide suddenly goes out, though, the relationship between financial turmoil and credit spreads matters again, as do the risks of downgrades. Asset classes previously inebriated from ultra-loose credit stagger back to reality. Government budget deficits suddenly count again. Hangovers abound as corporate-earnings multiples revert to normalcy and equity markets readjust accordingly.
The other problem Yellen is running into, just like Fukui a decade ago, is complacent politicians. Leaving the punchbowl out for too long takes the onus off governments to restructure economies, create jobs organically and increase productivity.
That, in a nutshell, explains why Japan is still fighting deflation two decades on. If only Fukui had stood firm with his rate hikes, a chastened Japan Inc. might be more vibrant today. Monetary policy is much looser now than in 2007, and Tokyo’s malaise persists. Yellen is bumping up against a similar monetary-traction ceiling—political gridlock rendering fiscal policy largely inoperable, while zero rates lose potency.
For now, Yellen seems inclined to leave the punchbowl out a bit longer. But as Japan’s experience tells us, 12-step programmes only work if you keep moving forward. For central bankers, that means a tough-love approach—and fewer refills.
William Pesek, based in Tokyo, is a former columnist for Barron’s and Bloomberg and author of Japanization: What the World Can Learn from Japan’s Lost Decades.
His Twitter handle is @williampesek