By Ambrose Evans-Pritchard
The Bank of Japan has been forced to retreat from further emergency stimulus after a blizzard of criticism at home and abroad, and warnings that extreme measures may now be doing more harm than good.
The climb-down by the world’s most radical central bank is the latest sign that the monetary experiments since Lehman crisis may have run their course. The authorities have not exhausted their ammunition but are hitting political and legal constraints.
The yen surged 3pc against the US dollar in the biggest one-day move in eight months and equities skidded across Asia after the Bank of Japan (BoJ) failed to take fresh action to stave off deepening deflation, catching markets badly off guard.
Governor Haruhiko Kuroda dashed hopes for ‘helicopter money’, warning that direct monetary financing of spending would be “illegal”.
Mr Kuroda insisted that the BoJ still has plenty of firepower and can at any time push interest rates even deeper into negative territory or boost bond purchases beyond the current $74bn a month. “If additional easing is needed, we will do so promptly,” he said.
The reality is that negative rates (NIRP) have backfired badly on every front. They have prompted bitter protests from banks and money market funds caught in a squeeze.
The yen has appreciated by 10pc since the BoJ first embarked on the policy in January, the exact opposite of what was intended. The rising yen - ‘endaka’ – is pushing Japan deeper into a deflation trap and undercutting the whole purpose of ‘Abenomics’.
Core inflation has fallen to minus 0.3pc. The Nikkei index of equities in Tokyo has dropped 13pc this year, with contractionary wealth effects that make the BoJ's task even harder. “Negative rates have completely failed,” said David Bloom from HSBC.
Washington will not tolerate the use of NIRP in any case, deeming it a disguised attempt to drive down exchange rates and export problems to the rest of the world.
Jacob Lew, the US Treasury Secretary, warned Japan and the eurozone at the G20 in Shanghai in February that the Obama administration is losing patience with use of beggar-thy-neighbour tactics by countries already running a current account surplus. They are in effect shifting their excess capacity abroad. Germany in particular is coming into the US cross-hairs.
Richard Koo from Nomura said the US is now on the warpath against currency manipulators. Mr Lew’s threat effectively renders Abenomics “dead in the water”.
The Japanese economy is contracting again, caught in a debt-deflation vice. Growth has been negative for four of the last eight quarters. What was once a ‘Lost Decade’ is turning into a “Lost Quarter Century” with no remedy in sight.
“Their options are diminishing. I can’t see any way out of the debt-trap, and it is an acid test for the western world,” said Neil Mellor from BNY Mellon.
Public debt is rising fast on a shrinking economic base, pushing the public debt ratio to an estimated 250pc of GDP this year. “The debt will never be ‘repaid’ in the normal sense of the word,” said Lord (Adair) Turner from the Institute for New Economic Thinking.
Olivier Blanchard, the former chief economist for the International Monetary Fund, warned recently that country is nearing the end-game as the pool of domestic funding for the bond market starts to dry up and the Japanese treasury is forced to rely on much more costly capital from global investors.
Mr Blanchard said the funding crisis risks coming to a head rapidly, forcing the Bank of Japan to plug the gap by printing money in a “life or death” gamble. This will ultimately lead to an inflationary spiral, a form of debt default.
Ryutaro Kono from BNP Paribas said the BoJ’s bond purchases are already soaking up the entire budget deficit, with as much to spare. “All the government has to do is to decide on more fiscal spending, and Japan will have begun a de facto helicopter drop,” he said.
Premier Shinzo Abe is already drawing up plans for a $100bn blitz of extra spending this year, and is hoping to cajole the rest of the G7 to support a joint fiscal expansion to pull the global economy out of the doldrums at a summit in May.
Mr Kono said the underlying problem is that Japan’s trend growth rate has fallen below zero as baby boomers retire and demographic crunch worsens. The slightest shock tips the economy back into recession. “This is something neither monetary easing or fiscal stimulus can rectify,” he said.
A shrinking workforce means that Japan can have a tight labour market – with unemployment falling to 3.2pc in March, and the job-to-applicant ratio rising to 1.3 – even though growth is negative. Nothing like this has been seen before in the modern world.
The only way out of impasse is a blast of deep reform to raise productivity and mobilize women. This means firing the ‘third arrow’ of Abenomics. There have been successes but it has been patchy.
‘Womanomics’ has raised female participation rate from 68pc to 71pc, chiefly by building crèches for children and better nursing care for the elderly so that women can work. The electricity monopolies have been broken up. The Trans-Pacific Partnership (TTP) was agreed in October and will be a wake-up shock for the backwaters of the Japanese economy.
Mr Kono said it may be a good thing if the BoJ fails to debauch the yen. Japanese companies pocketed the windfall gains from higher margins rather than investing when the exchange rate was weak, but on the other side of the ledger households suffered a serious hit to their living standards from higher import prices. The effect was asymmetric.
“Currency depreciation in the end only transferred income from working-age families to exporters, who are less inclined to spend. You cannot get results by doing this,” he said.