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Japan lets more than just interest rates stagnate
Just three days after the East Asia summit ended in Cebu, Japan struck another blow against the cooperation that Asian leaders talk so much about but practice so little. By leaning on the Bank of Japan to keep it from raising interest rates, the new Prime Minister Shintaro Abe shot himself in the foot as far as the neighbors are concerned.
All Abe's talk of a more outward-looking, assertive, Asia-centric Japan now comes to nationalism and defense spending rather than the increased regional cooperation that China has been dangling before the neighbors.
The Bank's failure to raise rates, is a recipe for more strains on other Asian currencies and a further delay in the currency and demand adjustments needed to reduce dangerous global imbalances. No wonder Japan is ignored internationally and constantly trumped by China on Asian issues.
The Abe government's action on interest rates has driven the yen to another record low against the euro and four or more year lows against the US dollar and most Asian currencies. All this despite the fact that Japan's economy has been expanding steadily, if un-dramatically, for several years, inflation has now returned, the current account remains in enormous surplus, official reserves stand at US$900billion and net Japanese private holdings of foreign, mostly US dollar, debt securities are roughly double that amount.
The incompetent, spineless bureaucrats who inhabit the bank of Japan and the Ministry of Finance and who brought Japan its decade or more of bust are now ensuring that the benefits of recovery will be sacrificed to the profits of exporters to the great detriment both of Asian neighbors and the Japanese consumer.
For sure, Japan's growth has been export-led. But that is hardly surprising given that the currency is now probably at least 30 percent undervalued relative to the dollar and euro and anything between 15 percent and 30 percent against Asian currencies ranging from the baht to the won and even the yuan. Exports are driven by demand levels of major partners not by maintaining a vastly undervalued currency.
Nor is it credible to believe that an interest rate rise, which would reduce the gap between yen and other rates, would hurt domestic demand. Households are large net savers so incomes would gain. Lower import prices would help consumers at the cost of exporters' profits but that would be good for the economy given the reluctance of corporates to distribute their gains either in wage increases for workers, which should spur consumption, or dividends for shareholders.
Internationally, Japan's position is doing major damage. It is diverting the pressure for Asian currency realignment away from Japan towards smaller, more vulnerable economies such as Thailand – hence the botched attempt of the Bank of Thailand to control capital inflows. It is slowing the appreciation of the Chinese yuan and has virtually halted any advance by the Taiwan dollar. While Japan behaves so irresponsibly, Asian neighbors cannot be expected to respond to demands by the US and others for currency appreciation.
Finally, the Japanese are a major cause of the glut of capital and low cost of funds which is creating a series of asset bubbles around the world. The so-called carry-trade by which investment houses, hedge and private equity funds borrow cheap yen and swap into dollars is one of the primary causes of the global liquidity glut. Whilst that glut is plain for everyone to see, the central bankers shy away from addressing the issue by speaking plainly about its causes. For sure, the US Federal Reserve and the government of China also have a lot to answer for. But Japan is at least as guilty as them, allowing its monetary policy to be set by internal politics divorced from the global financial world where Japan is a major player.
Unfortunately the US is too fixated on the China currency issue to turn its attention to Japan's role in international imbalances. The smaller Asian nations are too timid to speak up. And as for China, it must relish the inability of Japan to be a leader in Asia by using its financial muscle for the common good.