It’s hard to think of an economic story the global media got more wrong than Kazuo Ueda’s short tenure as Bank of Japan governor.
In the days before Ueda took the helm in April—and the 256 since—pundits were certain quantitative easing was done. In short order, the Massachusetts Institute of Technology-trained Ueda would exit 23 years of ultraloose policy, regardless of the fallout.
Not so much. More than 36 weeks on, the BOJ is as trapped in QE quicksand as ever. Team Ueda is warning traders not to get ahead of themselves with big bets on the BOJ normalizing rates.
Granted, 2023 didn’t go the way most observers expected. Few had China’s post-Covid “boom” fizzling on their Bingo cards. Nor did most think Japan would fall into yet another recession. There are few signs the current quarter is more vibrant than the July-September one, when growth contracted 2.9%.
Here, Prime Minister Fumio Kishida’s approval rating dwindling to 17% served up its own surprise. That will happen when inflation rises faster than the pace of economic growth or wages.
Still, the reason observers misread Ueda’s options so badly is they forget Japan really is a different economic animal.
Though Japan pioneered QE between 2000 and 2001, it seems to understand its pros and cons less than other central banks that employed the strategy. The Federal Reserve adopted and then exited QE without crashing the economy.
The same goes for the European Central Bank, the Bank of England, the Reserve Bank of Australia and others. The BOJ, though, is barely closer to scrapping QE than at any point over the last two decades.
Ueda’s predecessor Haruhiko Kuroda could’ve set the stage for normalization before retiring in April. He demurred, leaving Ueda with an unpalatable menu of options to clean up the BOJ’s mess.
Kuroda, after all, spent 10 years building up a titanically large BOJ balance sheet. This was indeed his remit when the ruling Liberal Democratic Party tapped Kuroda in 2013. His strategy to end deflation once and for all was hoarding government bonds and stocks to pump unprecedented liquidity into the economy.
Arguably Kuroda failed. For one thing, the inflation Japan is experiencing is largely imported via elevated energy and food costs. It’s not from organic increases in domestic wages or demand. For another, Japan is completely addicted to free money.
The specter of tighter BOJ policy in recent weeks sent shockwaves through corporate circles. Higher borrowing costs will have analysts reevaluating price-to-earnings ratio forecasts, affecting the broader stock market.
At the same time, talk of structural reform these last 10 years has been far more aspirational than real. If chieftains were reluctant to share profits with workers when Japanese yields were below zero, it’s doubtful they would fatten paychecks when rates hit 2% or 3%.
There’s also the tendency for the Tokyo political empire to strike back. In 2006 and 2007, the BOJ for a time managed to end QE and pull off two official rate hikes. It tipped Japan into recession, enraging lawmakers. By 2008, QE was back.
Since then, the BOJ has pulled the financial system even deeper down the QE rabbit hole. This increased the financial risks associated with rate normalization.
As Japanese yields rise, banks, companies, insurance and pension funds, endowments, local governments, universities, the postal savings system and the growing ranks of retirees will sustain big losses. The collateral damage to collective business and household confidence could be epic.
All this explains why observers continue to get BOJ decisions wrong. It’s important to remember that even when Japan is growing at, say, 3%, it’s only doing so with the help of super-loose monetary policy and ever bigger fiscal-stimulus jolts.
Since the 2001-2006 premiership of Junichiro Koizumi, arguably Japan’s most important reformer in decades, Tokyo has been promising to reduce public debt. Each successive government ended up adding to Japan’s debt burden.
As the debt-to-GDP ratio approaches 260% and the population ages and shrinks, Ueda might feel he has even less latitude to exit QE and start tightening.
Here, it’s best to view Ueda as a skilled BOJ leader whose hands are essentially tied by decades of complacency. Politicians who promised to recalibrate growth engines and increase competitiveness didn’t. BOJ leaders who talked a good game of scrapping QE found it easier to keep Japan on autopilot.
It’s this seemingly impossible gauntlet of competing risks that all too many economic observers seem to miss.
The BOJ’s 2024 might best be viewed as a giant economic Jenga game. The objective of dismantling a tower constructed of blocks without a collapse is easier said than done. One false move and all hell breaks loose in global markets.
So, faced with one option that’s just as precarious as the next, Ueda’s BOJ may be trapped in the QE zone longer than the conventional wisdom thinks.
