Unlimited Easing, Limited Power

Fisher Investments |

New Japanese Prime Minister Shinzo Abe got his wish this week: The Bank of Japan (BOJ) boosted its inflation target to 2% (rebranding it as a “goal”) and committed to open-ended monthly asset purchases of ¥13 trillion ($143 billion) to get there. And all Japan’s problems were … complicated.

Not that you’d know it from all the hoopla accompanying the announcement—observers globally hailed it as the aggressive move Japan’s waited 20 years for—but Japan’s monetary policy won’t change a ton in the near term. The open-ended asset purchases won’t begin until January 2014—until then, the current Asset Purchase Program continues as planned. At the moment, total outstanding purchases are about ¥36 trillion ($396 billion) short of the ¥76 trillion ($836 billion) target (Exhibit 1), so monthly purchases in 2013 will likely be well short of the ¥13 trillion everyone’s salivating over.

Exhibit 1: BOJ Asset Purchase Program (Outstanding vs. Target)

Exhibit 1: BOJ Asset Purchase Program (Outstanding vs. Target)
Source: Bank of Japan, as of 1/22/2012.

Timing technicalities aside, I’m not convinced even ¥13 trillion in additional monthly asset purchases will break Japan out of its deflationary funk. For one, the makeup’s a little odd: ¥2 trillion in Japanese bonds, ¥10 trillion in short-term bills and ¥1 trillion in other assets (commercial paper, corporate bonds, etc.)—not what you’d expect if the aim were lower long-term borrowing costs, though it may help steepen the yield curve a teensy bit. More importantly though, a decade (on and off) of monetary easing hasn’t brought inflation or nominal GDP growth (Exhibit 2).

Exhibit 2: Inflation, Nominal GDP and Monetary Easing

Exhibit 2: Inflation, Nominal GDP and Monetary EasingSource: Federal Reserve Bank of St. Louis.

One big reason why: Banks haven’t lent aggressively. The monetary base has more than tripled since 1999, but annual loan growth has been negative more often than not.

Exhibit 3: Annual Loan Growth and Monetary Easing

Exhibit 3: Annual Loan Growth and Monetary Easing

Source: Bank of Japan.

Instead, banks have either parked the new money back at the BOJ as excess reserves (Exhibit 4)—where they earn a risk-free 0.1%—or they’ve invested it in Japanese debt, where they can earn a fine real return despite ultra-low nominal yields (Exhibit 5).

Exhibit 4: Monetary Easing and Excess Bank Reserves

Exhibit 4: Monetary Easing and Excess Bank Reserves

Source: Bank of Japan.

Exhibit 5: Japanese Banks’ Government Bond Holdings

Exhibit 5: Japanese Banks’ Government Bond HoldingsSource: Bank of Japan.

Absent any structural changes to Japan’s economy, it’s difficult to envision ¥13 trillion in additional asset purchases every month materially changing this. Nor would removing the small payment on excess reserves. As I mentioned in my last column, bank holding companies—those at the center of the conglomerates, or keiretsu—have trillions of yen tied up in non-performing loans to unprofitable subsidiaries/affiliates, which incentivizes them to hoard capital. And with these unprofitable firms serving as barriers to new market participants, there aren’t a ton of entrepreneurs demanding capital to start or grow a nascent business. In fact, firms just aren’t investing much in general—business investment has fallen in real and nominal terms since nominal GDP’s 1997 peak. That (and the factors contributing to it, like waning productivity, outdated immigration policy, narrow labor markets and weak demographics), not too-tight monetary policy, is the most likely culprit for Japan’s economic issues.

That’s the bad news. The good news is, with money moving so slowly, Japan doesn’t seem to risk materially higher inflation in the near future. I don’t mean an economically productive reflation, which would see wages and prices rise in tandem—I mean a more problematic sort, where prices rise as more money moves faster, but wages stagnate or keep falling as companies don’t get healthier. If this were to happen, Japan would be in a tight spot: Savers would need a higher real return, which would likely force the banks to push huge amounts of funds from Japanese bonds into equities. This would nicely boost Japanese stock returns, but the government relies on domestic investors to support its high debt load (currently over 200% of GDP). Higher yields wouldn’t much help matters—they may help goad fixed income demand somewhat, but they’d make debt service a whole lot more expensive over time (they’d also diminish the value of existing bonds, which could cause problems on bank balance sheets if accounting rules don’t grant flexibility).

In my view, what Japan needs more than aggressive monetary stimulus is wide-ranging economic reform: Freer trade, freer immigration, broader labor markets, a privatized Japan Post (the state-run banking behemoth, which has likely fueled significant market distortions), and keiretsu reform to allow unprofitable firms to fail (i.e., creative destruction). Over time, this would promote economic and wage growth, solving Japan’s twin problems. Banks would feel far less pressure to rebalance away from fixed income, allowing the government more time to address its debt situation as needed. It would be a long process, and painful for those impacted by job losses, but it would set Japan on a far more productive and sustainable long-term path.

Unless Abe and his team address Japan’s structural issues, all the monetary stimulus in the world won’t do much good. Unfortunately, economic reform doesn’t appear high on Abe’s agenda—and only time will tell whether he figures it out before Japan’s revolving political door turns again.

This article constitutes the views, opinions, analyses and commentary of the author as of January 2013 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

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