financial times
friday septmember 11, 1998
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Japan's double or quits
Gillian Tett asks whether Tokyo has begun its long-feared monetary expansion and considers the implication
Ever since the Asia crisis began, it has been clear that Japan is the key to reversing it. And ever since Japan's ailing economy began not responding to an old-fashioned fiscal stimulus this year, it has been clear that, in extremis, the country might go for an unprecedented monetary expansion, letting the yen go hang.
On Wednesday night, almost unwatched by the markets, the Bank of Japan announced that it had decided to ease monetary policy for the first time in three years, pushing interest rates down and money supply up, in an effort to stave off a deflationary cycle. The yen tumbled Y4 against the dollar before recovering.
Has Japan begun that long-feared monetary expansion? If so, it is a double or quits decision. It might well help the domestic economy. It also shows that pressure is building up for a co-ordinated monetary loosening by the world's big central banks (yesterday, the Bank of England, while leaving rates unchanged, also said it would consider cutting rates if the world economy worsened).
But unless the US also cuts rates, Japan's decision would risk setting off a chain reaction of devaluations across Asia and Latin America, producing another round of global financial panic. The risk is real: emerging markets fell sharply yesterday, and a big monetary easing in Japan would increase the possibility of debt default in any country hit by a new wave of devaluation. If that were to happen, and if, say, a big western investment bank were to fall victim, then it could induce a crash in jittery global stockmarkets. As one worried trader put it yesterday: "The big question now is whether the Bank [of Japan] is going for broke."
The answer: not yet. By the standards of other central banks, Wednesday's announcement was complicated and timid. The official discount rate has been left unchanged at the record low level of 0.5 per cent. Instead, what the Bank has promised to do is to provide extensive liquidity to "guide down" the overnight call rate - which is the important one in Japan - from the current levels of slightly under 0.5 per cent to around 0.25 per cent. Although this rate is set by the markets, the Bank can influence it by injecting more - or less - cash each day.
The cut itself will probably have only a limited direct effect, say economists. But the Bank's statement also included an intriguing pledge. For "irrespective of the guideline for the call rate," the Bank promised that it would "provide more ample funds, if judged necessary, to maintain the stability of the financial markets." In central bank-speak, this implies that the bank could inject more liquidity into the markets without changing its interest rate target.
This does not automatically indicate a new policy. After all, the Bank has been pumping extensive amounts of liquidity into the market since last November to calm the financial crisis by ensuring that weak banks could still borrow funds (see graph). This has resulted in a dizzying expansion of the Bank's balance sheet and left it acting as a key financial intermediary in the markets. But it has not yet produced a real monetary reflation - the kind that might boost consumer spending and drive up prices.
Most of the expansion reflects operations which are the equivalent to short-term recycling of funds between banks. Bank reserves and bank notes - arguably, the best indications of real monetary growth - have been growing at a fairly stable level of around 10 per cent.
The key question now is whether the Bank would - or indeed could - now try to expand the level of "real money".
With interest rates now almost zero, monetary policy has now moved onto a new stage. To loosen monetary policy, the Bank needs to aggressively expand the money supply - probably through the purchase of government, corporate or bank bonds.
"If you are a central bank and you cut rates to zero and people still won't borrow money, then what else can you do?" argues William Campbell of JP Morgan in Tokyo. "You have to try and buy something with cash, and the only thing that the Bank can buy is bonds."
Might the Bank do this? Thus far, there has been little sign of it. One reason is that the Bank is sceptical whether even "free money" would provide an effective way to boost growth, given that consumers and companies appear reluctant to borrow at any cost, even zero. "From a historical perspective we are in a liquidity trap," one senior government official recently said.
Furthermore, until now the Bank has remained unconvinced by the arguments - being advanced by some western economists - that inflation will be eventually necessary to solve Japan's ballooning budget deficit. Pursuing a policy of deliberately stoking inflation, in other words, still seems a step too far.
But in recent weeks a new debate within the Bank has started, fuelled by the lively role that is being played by the policy board that was formed when the Bank gained independence over monetary policy on April 1. Some Bank watchers suspect that this could possibly produce a policy change further down the road. "I think the Bank is moving towards monetisation," argues Tetsufumi Yamakawa, economist at Goldman Sachs. "It is not there yet, but (Wednesday's decision) is one step in that direction."
This suspicion partly reflects the dire state of the economy and, above all, a growing concern that fiscal policy alone will not rapidly deliver growth unless it is accompanied by an additional boost from a weaker yen. There are fears, for example, that the trillion yen tax cuts announced by the government may be saved, rather than spent. There is also concern that the impact of public spending projects has dropped, not least because cash-strapped local governments are apt to spend central bank subsidies on repaying debts, rather than starting projects.
But the more pressing issue is the financial sector. As politicians have squabbled over banking reform in recent months, the Bank's concern about a fresh financial crisis has risen. Pumping "real" money into the system to ensure that weak banks can raise funds thus appears increasingly tempting.
"Japan has clearly entered its darkest hour - a final rate cut was always seen as a doomsday response," says Mr Campbell. "What I am worried about is that this is a pre-emptive move against another bank failure." In other words, the real nightmare is the fragile state of the banking system, and, in particular, the possibility that there could be a run on the banks.
Thus far, the Bank denies that such a financial crisis exists. Without one, most economists still suspect that the Bank will stay its hand. Indeed, the creation of the policy board means that it may take a crisis to create the necessary consensus among the nine members. "The bank will wait for a crisis to hit before it starts monetising the debt," says Brian Rose, economist at Warburg Dillon Read.
But with the September 30 fiscal half-year point looming, the pressures on the banking system are building again. A fresh bout of turbulence in the international equity markets remains another looming threat. Though some Japanese officials are now hoping that the US could be tempted to cut its own interest rates in response to the Japanese move to calm global markets, Washington has not yet delivered any promises. If the US does not act and if the Asian crisis deepens, Japan may let the yen slide - whatever the outside world thinks. |
