Japan has been conducting the most audacious monetary experiment in modern economic history, but there are plenty of signs the experiment has not been audacious enough. When Haruhiko Kuroda, governor of the Bank of Japan, convenes the bank's policy meeting this week, he will have to convince his colleagues that it's time for another round of shock-and-awe.
It's been 179 days since the last time BOJ took the markets by surprise. On Oct. 31, Kuroda rebooted Japan's quantitative-easing program to the tune of $700 billion. That massive injection is a key reason why the Nikkei is now at 15-year highs.
But even as investors have bid up Japanese stocks, deflation has made an untimely return. The BOJ’s main gauge showed inflation slowing to zero in February. In March, household spending dropped 2.9 percent, the 11th straight monthly decline. Wage gains remain stingy, a sign that spoils from the weak yen aren't trickling down. And the disappointment over the slow pace of Prime Minister Shinzo Abe's structural reform program is so widespread that Fitch's decided yesterday to downgrade Japan's credit rating to "A" from "A+".
It's easy to see why Kuroda might be reluctant to double down on QE. The yen's 30 percent plunge is enriching export giants like Toyota and Canon, but slamming small-to-midsize companies facing higher import prices. As the BOJ expands its monetary base, says Yoshimitsu Kobayashi, the new head of Japan's second-biggest business lobby, the "effect hasn’t trickled down, and I don’t think they can invigorate things with such unnatural actions.”
But having gone this far down an unprecedented policy road, the BOJ has no choice but to push on. When he took the top BOJ job in March 2013, Kuroda staked his legacy -- and the BOJ's very credibility -- on achieving 2 percent inflation for consumer prices by 2016. That target is still very far away. All indications point to deepening deflation, with the prices of oil and other commodities weakening and disposable income stagnating. As Fitch complained, "Japan's macroeconomic performance is a rating weakness."
Moreover, the political pressure on Kuroda is mounting. There's been plenty of discussion in the media about tension between Kuroda and Abe, who worries the BOJ is being too timid about adding fresh liquidity. Abe's team was also taken aback by Kuroda's April 23 comment -- a gaffe, really -- that BOJ staffers were studying the technical details of exiting quantitative easing. The very next day, Abe advisor Kozo Yamamoto unloaded. "I’m worried the BOJ’s attitude is wavering,” he told Bloomberg News. “I wonder if Kuroda is being affected by fukumaden,” a phrase that means “den of conspirators.”
Abe is also making the case by tapping 45-year Toyota veteran Yukitoshi Funo to be the central bank's newest board member. Funo, who is thought to be very dovish, is expected to replace a policy maker who voted against the last round of quantitative easing.
There's another reason why the BOJ is essentially trapped into its QE program: financial markets. The slightest hint the BOJ's easing experiment is winding down would send bond yields sharply higher -- and the Nikkei plunging. Japan, it's easy to forget, is the world's most indebted nation, with a shrinking population to boot. The glue holding its financial system together is 10-year bond yields at 0.28 percent. Were they to rise above 1 percent, it could trigger financial panic. For better or worse, the BOJ stepped onto a monetary treadmill in October -- one that will be much harder to exit than some policy makers appreciate.
Kuroda should have the courage of his earlier convictions this Thursday. The BOJ should ramp up its annual government bond purchase by $100 billion or $200 billion (or more), while pumping more cash into real-estate and exchange-traded funds; asset-backed and mortgage-backed securities; and "zaito bonds," which state-run companies sell to fund projects. Kuroda also should pledge massive purchases of regional-government IOUs to shore up Japan's struggling hinterlands.
By going big, Kuroda could stem what he has called Japan's "deflationary mindset." Even a little more monetary shock-and-awe might be able to carry the country a very long way.
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