Commentary: Printing Yen Is Not the Answer

By Brian Bremner

Has the Bank of Japan blinked? Despite two years of withering political heat, BOJ Governor Masaru Hayami has resisted calls from inside the ruling Liberal Democratic Party to rev up the economy by opening up the monetary floodgates and printing yen like crazy. The BOJ would use much of the funds it created to buy government bonds. That would foot the bill to keep the government's perpetual spending spree going--and dodge the need for fiscal discipline.

This sort of radical gambit--known as debt monetization in central-bank lingo--conjures up images of Germany's Weimar Republic. And Hayami has argued that short of some sort of catastrophe, it shouldn't be tried in Japan. In Japan's case, monetization wouldn't induce runaway inflation à la Weimar: Japan, in fact, is plagued by deflation. But it would zap what little reformist zeal Japan has left and would encourage policymakers to put off the tough measures--bank cleanups, corporate downsizing, debt workouts--that the country needs to get out of its 10-year funk.

What's more, monetizing the debt would keep an artificial lid on bond yields--now all of 1.3%, the lowest in the developed world--and thus long-term interest rates, since the market would see the BOJ as the buyer of last resort. To a purist like Hayami, higher rates would force the government to work harder to mend its ways. No surprise, then, that in a May 30 speech, Hayami hit the reform theme once again, warning that "we should not be complacent."

Now, however, some argue that Hayami is bending to government pressure. Exhibit A: Japan's money supply is exploding. The country's monetary base, which includes cash in circulation and reserves held by Japanese commercial banks at the Bank of Japan, grew at an annualized pace of 29% in May and a sizzling 36% in April, vs. an average of 15.6% in the last quarter of 2001. For most developed countries, single-digit growth is the norm.

Which leads us to Exhibit B. The central bank isn't just providing liquidity for the banks, it has also developed a ravenous appetite for government bonds. Back in February, the BOJ announced that it would increase its direct purchase of bonds from $6.4 billion to $8 billion a month. At that rate, estimates Standard & Poor's sovereign credit analyst, Takahira Ogawa, up to 40% of the Japanese budget deficit in this fiscal year could be funded by the BOJ. That would be more than twice last year's level and certainly aids and abets the profligate politicians.

That surge in bond purchases has set the alarm bells ringing. "Outright debt monetization has started," Merrill Lynch & Co. senior economist Jesper Koll recently wrote in The Daily Yomiuri. S&P's Ogawa also thinks that the BOJ caved. With tax revenues falling and government debt now about 140% of gross domestic product--instead of between 40% and 60% as in most countries--strong-arming the central bank into funding the budget is the "last avenue to stabilize the government's debt trajectory," he figures.

The BOJ insists that all this talk is sheer nonsense. Sure, it has raised its daily targets for banking-system reserves five times since March of 2001 and created the cash for the system to meet these targets. On Feb. 28, it pushed up its target from $40 billion to as much as a staggering $120 billion. But the BOJ swears it had good reasons. First, it says, it needed to calm jittery markets worried about the possibility of major bank failures at the end of the fiscal year in March, when a weak Nikkei stock average and mounting dud loans pounded the earnings and capital base of big Tokyo money-center lenders. Then, in April, a computer crash involving the ATM network of Japan's biggest bank, Mizuho, raised the specter of a run on deposits there and at other banks. The Bank of Japan was merely responding to the need to keep the cash spigot on, as the minutes of its Apr. 30 meeting, released on June 17, show. The central bank also says buying bonds is a tool that it needs to hit its daily reserve targets.

Maybe, but with the banking system stabilized again, deflation showing signs of easing, and annualized first-quarter growth reported at 5.7%, it is hard to justify such a radical ramp-up in bond purchases. Japan's economy is weak, but the Weimar Republic it isn't. Yes, ultraloose monetary policy will come in handy should Japan's economic reforms ever get off the ground--but only then. Perhaps it's time for Governor Hayami to reclaim his reformist credentials and bring the binge to a halt.

Bremner covers finance from Tokyo.

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