Central banks are back on the center stage of the global economic policy debate. The U.S. Federal Reserve and the European Central Bank now appear ready to ease monetary policy — in a turnaround from just some months ago when people were looking for “exit” and additional rate hikes.
In time-honored fashion, as soon as recession risks rise, pressure for monetary countermeasures goes up. The more ambitious political leaders are, the more intense the pressure gets. Unfortunately, there is growing evidence that monetary policy alone cannot do the trick of getting economies back on track. Money may make the world go round, but money alone does not create sustainable economic growth and prosperity.
No country serves as a better real-world example for the potential impotence of monetary action to create growth than Japan.
It was exactly 20 years ago when Japan’s experiment with aggressive and unconventional money policy started: In the spring of 1999, the Bank of Japan pushed the price of money down to zero; several years later this was followed with the first foray into “quantitative easing,” which has basically stayed in place ever since. Since 2013, the BOJ under Gov. Haruhiko Kuroda has engaged in a more aggressive policy of monetary stimulus with massive asset purchases by the central bank.
Like all experts, economists sometimes love to get lost in the details — like, what exact assets did they buy? What maturity do those assets have? Is the speed of asset purchases accelerating or decelerating? These are all interesting questions for financial market professionals and arbitrageurs, but they more often than not distract from the really important fact: Yes, Japan has been pushing the envelope of central bank action longer and harder than any other central bank in the world.
The unprecedented liquidity creation is reflected in the BOJ’s balance sheet blow-up, from total assets of around ¥73 trillion in mid-1999 to around ¥562 trillion in mid-2019. This is a 7.7-fold supersizing, significantly more aggressive than the 6.5-fold expansion conducted by the U.S. Federal Reserve.
But Japan’s nominal gross domestic product has barely budged. Clear speak: Twenty years ago, ¥1 from the BOJ supported ¥7 of GDP; today, that same ¥1 from the BOJ barely creates ¥1 of GDP.
So clearly, the daring-do, record-breaking efforts by the BOJ have very little to show for it. In fact, one of my favorite quotes is from former BOJ Gov. Masaru Hayami, who served as Japan’s top central banker from 1998 to 2003. It was Hayami who cut rates to zero (which no central bank anywhere had ever done before). When pressured by politicians in the Diet to do more, he calmly replied: “We’re doing everything we can, but trust me it will do no good” (or words to that effect).
Why is it that central bank action alone does not create growth? It is because only the private sector can create true economic value — jobs, income, competitiveness and prosperity. Money has no value if it’s not backed by assets, and assets have no value if they are not made to sweat harder by private entrepreneurs — capitalists together with their employees and other stakeholders. The real lesson from Japan is not that the BOJ did “too little, too late,” but that it has been doing too much for too long. Let me explain.
Like a good detective, let’s follow the money. Who actually benefitted the most from the BOJ’s action? Where did the liquidity that the central bank created go? Whose assets did the BOJ buy to blow up its balance sheet? One answer: the government in general, the Finance Ministry in particular.
Specifically, in 1998 there was ¥295 trillion in Japanese government bonds, and the cost to service this debt was almost ¥11 trillion. Today, the public JGB debt has swollen to almost ¥900 trillion, but the cost to service this debt has fallen to just above ¥8 trillion. What a great deal: treble your debt but cut your interest expense by almost a third. The government is the clear winner here. Bonus: Almost half of your debt is now owned by the central bank, which, of course, is part of the government. Make no mistake, a significant part of Abenomics is de facto the largest experiment in financial socialism ever seen.
The good news is that there appears to be no problem with this policy. Yes, GDP is still basically flatlined, but unemployment is down to a historic low and corporate profit is at a record high. Most importantly, there is absolutely no evidence that Japan’s unprecedented Liberal Democratic Party-Finance Ministry-BOJ nexus and debt monetization has forced a debasing of the currency. There is no inflation and Japan’s currency is basically stable. (The yen has both depreciated and appreciated and cannot be described as “manipulated” by the BOJ.)
All this runs counter to conventional economics, which had always insisted that Japan-style debt monetization would sooner or later result in inflation, possibly even hyperinflation, domestic asset bubbles and a collapse of the currency. In my view, Team Abe deserves much credit for daring to try the unthinkable: forcing monetary and fiscal policy into one tool that is dead-set on promoting the national interest.
The bad news is that Japan’s unique financial socialism is crowding out private entrepreneurship. This is taking place in three ways: First, with the cost of debt basically free, there are no market-based checks and balances on public spending. The de facto blank check to the government from the BOJ risks breeding an ever-growing public sector, a “nanny state” with an ever-growing part of the population pulled into dependency on government handouts and support. Second, with the BOJ dominating asset markets in general, the bond market in particular, Japanese financial markets are increasingly distorted and cannot possibly allocate capital in the best and most efficient way. A zero-cost debt and loan market does not only allow “zombie” companies to stay alive, but incentivizes excessive competition. Lack of creative destruction clogs the arteries of commerce and industry, and stifles innovation.
And last but not least, Japanese households are massive savers and the single biggest creditor to the economy. They lord over almost ¥900 trillion in bank deposits alone. The fact that by now an entire generation of Japanese has never received interest income has no doubt been a consistent drag on consumption, particularly since an ever-growing part of the population is living off their pension and asset income.
All said, Japan’s experiment in financial socialism has been more of a positive force than a negative one. Let’s not forget that the starting point was a real national crisis. However, in my view, the next generation of political leaders will need to push harder to create more room for private enterprise and entrepreneurship by withdrawing the BOJ’s life support.
Based in Tokyo, Jesper Koll is the senior adviser to WisdomTree Investments. Researching and investing in Japan since 1986, he is consistently ranked as a top Japan strategist/economist. He publishes blogs at www.wisdomtree.com/blog .
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