BEPPU, OITA PREF. – If one were to look at Japan’s financial policies using the common knowledge found in university economic and financial textbooks, one would find that they contain many unfathomable things.
According to theory, if there is a sufficient number of transactions (liquidity) going on in the market and prices are determined through free trading by diverse participants, then it is a good market. Then what is happening in Japan’s financial markets?
In the bond market, nearly half the Japanese government bonds are owned by the Bank of Japan. The yield curve has long remained largely flat due to the central bank’s zero interest rate and quantitative easing policy. This seems pretty much to be a distorted market.
Turning to the stock market, the central bank has already become a major shareholder of 50 percent of the nation’s listed companies. According to a forecast by the Nikkei daily, the BOJ is set to be Japan’s largest shareholder by the end of 2020, topping the Government Pension Investment Fund (GPIF). Either way, the government sector represented by the BOJ and GPIF will become the top two players in Japan’s stock market. Like the bond market, this is a fairly distorted market structure.
What’s even more serious is that an exit to normalizing such conditions of the markets remains nowhere in sight. The government and the BOJ should at least publicly present several possible scenarios toward normalization of the markets.
Exchange rate policies
In 1973, Japan moved to a floating exchange rate system. The current exchange rate of the yen, when measured by the real effective exchange rate, which roughly indicates the international competitiveness of Japanese businesses, is about 30 percent below the average rate over the nearly half century since 1973. This shows that the yen is significantly depreciated.
According to textbook theories, a policy of lowering the value of the national currency means reducing in relative terms the price of production elements as denominated in the national currency. This is nothing short of a beggar-thy-neighbor policy. In other words, we are “dumping” the nation’s labor force.
The International Monetary Fund prohibits operations to depreciate the exchange rate of a national currency for the purpose of creating an advantage for the nation’s foreign trade. Group of 20 finance ministers and central bank chiefs have repeatedly agreed that member countries need to avoid competitive depreciation of their currencies.
Japan has consistently argued that the yen’s depreciation is not the result of exchange rate manipulation but an outcome of monetary policy designed to boost domestic demand. Even if the weaker yen is indeed an unintended result of a policy measure, a long-term depreciation of the yen could in the end gradually sap the nation’s economic vitality. A sustained dumping of the nation’s labor force can hardly be considered a policy to make the economy stronger.
In Japan, which achieved its postwar reconstruction through the manufacturing factory model — that is, through exports — popular sentiment still backs the belief that a weak yen is good and a strong yen is bad. But Japan is a country with a large domestic demand, and the weight of external demand on its economy is quite low, ranking 186th of 207 countries in 2017.
The challenge going forward is to change the popular mindset into one that views a strong yen as good and a weak yen as bad. It’s difficult to find historical examples of a country that has pursued depreciation of its own currency for decades. Even U.S. President Donald Trump, who seems dead-set on pursuing a trade surplus for his country, advocates for a strong dollar.
It almost seems that Japan has forgotten the historically established common sense notion that boosting the nation’s own value — as represented by its national currency — is the right policy. It will be fortunate if my concerns about this prove unfounded.
The future of banks
Banks play a core role in the nation’s financial sector. Their profits derive from interest rate differentials, according to textbooks. It is also commonly understood that banks perform the function of transferring excess savings in the household sector to the business sector that suffers from funding shortage.
However, interest rates in Japan remain close to zero because of the BOJ’s zero interest rate and quantitative easing policy. That the yield curve remains nearly flat means that there is no prospect of interest rates going up for the time being. Under this condition, how can Japanese banks make a profit through interest rates differentials?
In addition, more than two decades have passed since Japan’s private business sector shifted to excess savings in the mid-1990s. According to the Finance Ministry’s fiscal 2018 financial statements and statistics of corporations, the retained earnings held by Japanese firms reached a record ¥463 trillion. From a macroeconomic viewpoint, there is no way a strong funding demand will emerge out of such a condition.
Banks could find a way out by engaging in asset management if the business sector is in a state of excess savings. Japan’s financial markets, however, are becoming dysfunctional. In addition, interest rates are nearly zero and the nation’s economic growth, which from a macroeconomic viewpoint is linked to share prices, is conspicuously low among major industrialized economies. Under such conditions, banks may have no choice but to invest in foreign currencies. But aside from the problem of exchange rate risk, it is questionable whether they have greater knowhow of foreign currency investments than their overseas rivals.
What future does either the government or the BOJ see in the nation’s banks? Neither of them has been able to present a plausible solution to any of the three problems outlined here, which seems to be a case of negligence on the part of the government or the central bank.
Haruaki Deguchi is the president of Ritsumeikan Asia Pacific University in Beppu, Oita Prefecture. A popular lecturer and author of more than 30 books, he founded Lifenet Insurance in 2008 after a career spanning nearly 35 years at Nippon Life Insurance Co.