By: Enzio Von Pfeil

Japan’s politicians and the Bank of Japan appear unable or unwilling to get a grip on their economic problems despite Prime Minister Shinzo Abe’s vaunted quiver of economic arrows, the most potent of which – restructuring – remains sheathed.

In effect, the country has broken its Economic Clock®, with crazy investment implications. A broken clock tells the time twice a day. Policy is characterized by an excess supply of money and an excess supply of goods – a condition in place for many moons already.

Japan’s politicians have refused structurally to reform the economy, to put some power behind Abe’s third arrow. We see this clearly in the continuation of Japan’s closed labor and goods markets, not to forget the enormous power exercised by Japan’s farmers, lack of immigration, lack of openness to foreign direct investment and that crucial reform: to allow failed business actually to fail.  Thus, Japan simply no longer has a business cycle at all.

The Financial Times in early February reported that the Bank of Japan “now combines negative shorter-term interest rates with annual asset purchases of  ¥80 trillion (US$670 billion), equivalent to 16 percent of gross domestic product, driving down interest rates across the yield curve. A lack of demand from borrowers means it has not stimulated much growth in credit, however.” 

So there is no business cycle!  Nevertheless, BoJ Governor Haruhiko Kuroda doggedly insists that there is no limit to monetary easing “…as he vowed to slash interest rates deeper into negative territory if necessary.” 

This reminds one of ECB chief Draghi;’s “whatever it takes” comment. How does Haruhiko Draghi sound to you?

There have been two policy errors: the focus on inflation and the attempt to generate inflation  via negative interest rates. The focus on inflation has been misguided. The business cycle works only if the economy is firing on all pistons, e.g. on demand-pull inflation (“inflation”) and competition, to name two crucial ones.

Thus, without structural reform, inflation cannot return.  If structural reforms allow for inflation, then the lack of reforms disallows inflation. It is logical. We just now have asserted that Japan’s politicians are disallowing structural reforms, thereby killing Japan’s inflation and thus business cycle.  So why focus on inflation at all, when structural reforms should be the focus?

Neither can negative interest rates work. All of us know that the BoJ introduced -0.1 percent (by a slim majority of 5 to 4 on Jan . 29 on banks’ new excess reserves held at the central bank. This was hard on the heels of Switzerland’s -0.75 percent, Sweden’s -1.1 percent, Denmark’s and the Eurozone’s introductions of negative rates. Indeed, on Feb. 9, Japan’s 10-year government bond “yielded” -0.05 percent.  Negative rates have been introduced in order to stimulate trade as well as consumption, cheapen lending and enhance banks’ profitability. Can these results possibly be achieved?    

Theoretically, negative rates must lead to currency depreciation: after all, why hold the yen if you are paying for the honor? In practice, the yen (along with the Swiss franc) have risen in value.