Perspectives from Around the World

The Sun Goddess! Please Never Turn Back Again!

Tuntex Professor of Economics, Yale University

On February 14th this year, Japanese people were surprised by an unexpected "Valentine" present from the Bank of Japan (BOJ). I thought of it as a present, because it adopted a policy of inflation of 1 percent and increased the allowance for purchase of Japanese Government Bonds. The stock market responded to this favorable news and spiked to carry the Nikkei index over 10,000. The yen/dollar exchange rate depreciated from 76 to 82 and offered some relief to export industries that are suffering from an exceptionally appreciated yen. Recently, no other factors in the world economy affected the Japanese market in favor of recovery more than this "Valentine" policy change.

After the legislation of the Bank of Japan Law (legislated in 1997 and enforced in 1998), the path of the Japanese economy trailed behind those of advanced countries as well as those of emerging economies in the world. Among advanced countries, Japan is the only country that suffers from prolonged deflation as well as from the appreciation of its currency, the yen. Since both indicators are exactly the relative price of the yen to goods and to the dollar, this obviously shows that the shortage of liquidity supply by the Bank of Japan has been a major factor causing the low performance of the economy.

My joy in the receipt of this Valentine present did not last long. After a month or so, BOJ Governor Masaaki Shirakawa travelled to the Federal Reserve Board (FRB) and gave a lecture representing an old BOJ doctrine that monetary policy may not be effective to halt deflation. In a conference in Tokyo, he even mentioned the diminishing working population in Japan as a possible culprit. Certainly, population decline is a major determinant of growth, but it is nothing but a 'red herring' to deflation.

In fact it was Governor Shirakawa himself who brought back to Japan from Chicago, the monetary approach to exchange determination that would provide the exact recipe for recovering Japan's economy under the extreme appreciation of the yen (endaka). I once begged him to recall the right "song," that is, the right approach to the exchange rate determination that he knew and to "sing" it again. Dale Jorgenson of Harvard University kept asking me when various policy attempts by the BOJ policy in the past occurred, if they were "singing the right song." My answer was generally "No," until this Valentine present, the adoption of the inflation target even though 1% is at most a half step to the proper step, that is, at least 2% as the FRB did.

According to a Japanese myth, the Sun Goddess once hid in a cave casting everything into darkness. When she wanted to peep into the cheery outdoors created by tactful gods, she opened slightly the rock of the cave. Then a powerful god made the rock door open completely, and the sun came back to the world. In this Valentine case, it was as if the BOJ opened the door very slightly (1% inflation prospect), but not entirely (like 2% inflation target). At a major press conference in Japan, the Governor declared that he intended to brighten up the economy. The market at once reacted positively. In his press conference with Reuters and his address at the FRB, however, he has seemingly retreated to his old position of the BOJ doctrine that monetary policy cannot cure deflation because of the lack of real demand.

Japanese people finally realized that monetary policy is an effective weapon against a weak stock market as well as against the over-appreciated yen. They visualized that they could enjoy the sunlight, the effectiveness of monetary expansion and its commitment. Political developments in Europe and the fear of stronger American monetary policy made the Japanese stock market weaker, and the climb of the yen resumed. Economists, journalists and politicians working as watch dogs of the BOJ feared, or even, in some cases, cheered these moves as evidence of inefficacy of monetary policy.

On the contrary, the recent moves of exchange rates illustrate clearly that the monetary approach to the exchange rate determination, a gift of Governor Shirakawa to Japan, proved right. European (or American) real weakness and American monetary expansion actually strengthen the yen as happened in late May. The moral is that the BOJ needs to act more firmly like making the inflation target 2% as in the United States. Japanese audiences should not be misguided by journalists, economists, and scholars who defend the old BOJ doctrine by saying that monetary policy does not work. These recent trends demonstrate the legitimacy of the theory and evidence of the lack of "guts" in the BOJ for pursuing the right policy.

Let me mention the recent incident, the collapse of "Elpida," a Japanese memory chip firm. The economic failure of Elpida may stem from various causes including structural and managerial mishandling. In this case, however, the major reason is nothing but the historically unprecedented high value of the yen. As Elpida's CEO clearly mentioned in a press interview, the extremely high yen gave the company a hurdle impossible to clear. Imagine that Japanese firms and Korean firms have 60% cost difference just because of the combined effect of an appreciating exchange rate and a depreciating exchange rate respectively both 30% vis-à-vis the dollar. No efforts for technical cost saving or the industrial policy trying to enhance the competitiveness of Elpida could compensate for this enormous cost hurdle coming from exchange rate movements. Thus, Elpida failed for no other reasons than the expensive yen. Since the yen exchange rate is fundamentally, if not solely, determined by monetary policy, the BOJ is mainly responsible for the collapse of the company.

A substantial number of suicides that stop commuting trains in Japan almost every day can be traced to economic difficulties. Central bankers in Japan seem not to be aware that the BOJ policy affects every facet of life of the Japanese people by prolonging deflation and increasing bankruptcies and unemployment.

The stringent monetary policy that works through the appreciation of the yen is a bullying policy that eliminates weaker firms. This was the essence of the policy of Junnosuke Inoue during the 1930s. Inoue was glorified in some literature but actually led the Japanese people into the depth of inter-war depression by artificially fixing the exchange rate too high. His policy was often referred to as the "liquidation principle of inefficient firms." Elpida was one of the firms that were to be liquidated. Many export industry firms, such as Sony, Panasonic, and Sharp, that were major promoters of Japan's high growth period are now in positions of near liquidation.

This expensive "bullying" policy damages the weaker firms, particularly export industry firms. The policy conceived against "endaka" by the Noda Government was not against the appreciation of the yen, but rather the policy to promote the "hollowing out" of Japan by facilitating the takeovers of foreign firms. This government is helping the hollowing out of the country through substantial cost to taxpayers.

Naturally, a policy of hollowing out an industry is the policy of eradicating local industries. Firms in Tokyo may survive either because of high productivity or as a result of the fact that even firms exporting their production abroad may need Japan's headquarters in Tokyo. Local firms cannot survive in the same way. Decay and frustration prevail in local areas. In this sense, "Osaka Ishin (reformation initiative)" has reasons to be vindicated.

Many scholars, business economists, and journalists may be aware of the economic mechanism just described above, but refrain from expressing their understanding openly because of pressure from the BOJ, the Ministry of Finance (MOF), or their peers. Or, they may be ignorant about the fundamental mechanism. Ignorance, however, is not at all a token of indulgence. As Shozo Tanaka, who fought against the pollution of copper mines in the Meiji period once declared in 1900, "Those who do not know that they are walking on the way to ruin are themselves paving the very way to ruin."

I will now cite and fully endorse the following crystal clear statement in an issue of Weekly Shincho by Masahiko Fujisawa, a well-known writer. If a novelist can understands economic logic so well, why do central bankers, bureaucrats, politicians, economists and scholars fail to understand or pretend not to understand the simple truth of monetary economics?

"The BOJ, rather than the MOF or the business circle, is most responsible for the malfunctioning of the Japanese economy. The BOJ is largely responsible for letting the economy continue in recession for 15 years. After the Lehman crisis, the FRB increased its money supply by three times. Similarly, central banks of the UK, China and Korea also stimulated their troubled economies by increasing money supply in a dramatic fashion. The BOJ increased its money supply only very little. Because of this contrasting inaction, the yen appreciated against the dollar and the euro by about 30% and against the Korean won by about 60%. What to do now for Japan is to print a huge amount of money equivalent to several hundred million dollars to purchase government bonds. Then the government spends the money to accelerate recovery from earthquakes and increase the nominal rate of growth. Increasing the amount of Japanese money in circulation will depreciate the yen. The 'hollowing out' of Japan will be halted. More than 10,000 people have killed themselves because of financial reasons. The Bank of Japan never moves!" (Weekly Shincho, February 26, 2012.)

June 1, 2012

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