Monetary Limbo Brings On Nowhere Growth

Monetary Limbo Brings On Nowhere Growth
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The August 2000 regular monetary policy meeting of the Bank of Japan was a highly contentious if not momentous gathering. The Bank had only obtained its so-called independence from the government in early 1998 with the Bank of Japan Law. Being unshackled from direct control for the first time, it didn't take very long for the Bank to exercise its newfound discretion. In February 1999, BoJ adopted ZIRP, a world's first, in an attempt to push the Japanese economy out from under not just the lingering effects of the 1989-90 collapse but also then the further negative pressures from the Asian flu.

Though it had promised to hit zero rates that February, it wouldn't be until April 1999 that the policy was further clarified to where ZIRP was intended to remain in effect until the "deflationary concern is dispelled." Japan's CPI rate had been positive again starting in 1996 and much more so in 1997, but the global dollar problem that started in Thailand was began exacting a heavy toll. Whereas Japanese inflation peaked at a more hopeful (to economists) 2.5% in October 1997, just nine months later in July 1998 it was negative all over again.

When the BoJ policy board gathered in August 2000, there really wasn't any direct indication that ZIRP had achieved its goal - to "dispel" deflation. The CPI had ended the prior year, 1999, at -1.2% and -1.1%, respectively, that November and December, and by the summer of 2000 it was still negative if only slightly less so. By the time the meeting was held, the Japanese CPI had registered -0.5% inflation for July 2000. The committee set that aside and instead looked for guidance at least in some part from the "maestro."

In 1994, finally pushing past the first "jobless recovery" in the US, Alan Greenspan had raised the federal funds rate when it was far from expected. The economy still appeared weak and many economists felt further low interest rate "stimulus" was warranted. Greenspan felt confident enough to override those concerns and engineered what many still describe as a "soft landing." It was this episode and the conditions that immediately followed that delivered to him the nickname "maestro" in the first place. A very few who used the term did so correctly as sarcasm.

Several BoJ officials by the middle of 2000 felt that the Japanese economy had been steered into a similar state as the US economy seven years prior. Though inflation might still be negative, there were encouraging signs that "stimulus" was working. Because of some positive numbers elsewhere, many believed there was no need to wait until the CPI, as a somewhat backward or at least coincident indication, turned fully positive. As the meeting minutes record (translated by BoJ staff):

"Many members' view on the economic and financial situation was as follows. First, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. Second, the employment and income situation had stopped deteriorating and was starting to improve. Third, the economy was likely to recover gradually led mainly by business fixed investment, unless there were major adverse external shocks. Fourth, downward pressure on prices stemming from weak demand was declining significantly. And fifth, in the financial market, no significant spreading of concern over the financial system or notable deterioration in market sentiment was observed."

Based on that review and outlook they made the determination that 1999's criteria had been met, "the economy had reached the stage where deflationary concern had been dispelled." Not everyone agreed, and not just the lone dissenter on the committee itself.

The Bank of Japan Law of 1998 had not completely erased the government from monetary policy, though its role would be more symbolic than of force and dictation. Under the prior central bank arrangement, a framework that dated back to 1942 and a wartime structure modeled on Germany's Reichsbank, the Japanese government could override any BoJ policy, meaning that in practice the Bank was just a committee of perhaps experts who would offer recommendations. The committee itself included government officials, not just BoJ staff.

The new and independent BoJ was free to make and adjust policies, but the government would be present inside at policy discussions, though its representatives were no longer given voting rights. At most, the Japanese government could request a postponement of any policy vote, registering in the official public record its potential disapproval.

The August 2000 policy meeting was one in which everyone expected the BoJ to vote for a rate hike. They had practically assured the Japanese of that outcome by talking about it for months beforehand, as central bankers seem to want to do in their version of "modern" monetary policy. The Japanese government of Yoshiro Mori was very much against it. The conference itself turned into a marathon eight-hour session, and when the time came to propose ending ZIRP with a 25 bps increase in the reference rate, the uncollateralized overnight call rate, government representatives led by Yoshitaka Murata, Senior State Secretary for Finance from the Ministry of Finance, requested and was granted a 20 minute recess to discuss whether they would officially press for first a BoJ vote on postponement.

After the delay, Japanese officials came back with that official invitation to put off the decision until the next meeting. The minutes don't record what was said or how long the BoJ committee took to consider the government's objections, but after some time they voted against adjournment before voting for the rate hike. As is usual in these kinds of circumstances, the committee also voted to ensure that their statement about the rate hike made very clear that this was not in any way (in their view) an end to "accommodation", rather it was, "a small adjustment to the degree of monetary easing in line with the improvement of the economy."

There are those who argued then and still do today that the vote was as much about BoJ independence as it was about the Japanese CPI or economy. I don't doubt that was a consideration particularly after the official postponement request that would become part of the public record, but their whole argument was about improving economic conditions that would in short order be felt by everyone and everything, including the CPI. In short, they were arguing for their own competence. Tellingly, it was the government officials who actually brought up the negative CPI as a significant consideration against the BoJ position.

Murata pointed out that though the economy did seem to be improved and corporate Japan's position strengthened, Japanese households remained under severe strain and private consumption was "more or less unchanged" from low levels. From this view, "It was not yet clear whether the substantial improvement in corporate profits would lead to an improvement in the employment and income situation and an increase in private consumption." After the decision, Prime Minister Mori heavily criticized the decision as "premature."

And after an embarrassingly short period of time, in March 2001, just seven months later, BoJ was voting ZIRP again though this time with an added "quantitative easing" component that had actually been discussed the prior August. Though the CPI would stay in much the same range throughout, by the beginning of 2002 it was back around -1.2% and even -1.6% (February 2002) that wasn't any different than the last months of 1999 and the fading remnants of the Asian flu.

Mori's government though seemingly vindicated in its opposition argued wrongly that the risks of the "fragile recovery" being "derailed" by a rate hike were too high. It wasn't monetary policy that ended up humiliating the Bank of Japan; it was the NASDAQ, or at least the growing dot-com bust. The August 2000 BoJ policy minutes document some concern on the part of some BoJ officials that, "although the robust expansion [in the United States] led by domestic demand continued, the view that the economy was slowing down grew stronger as household spending, such as housing investment and consumption of durable goods, started to slow."

The dot-com recession would be "somehow" another global downturn, and like the Asian flu would impact the "fragile" Japanese economy particularly hard - no matter the small variations of "accommodation."

The Bank of Japan would be more careful the next time after the global storm of the stock bubble had passed. Appearing in no particular hurry, the Bank would not even consider a shift in policy again until 2005. And even then they would wait a further year before acting. When they did, in the summer of 2006, they made all the same mistakes all over again. Though the government didn't formally object by requesting a postponement of the July 2006 vote, it wasn't fully onboard with it even though publicly there seemed to be a unified opinion. Economics Minister of the time Kaoru Yosano said in a speech just before the BoJ decision that a rate hike would be, "a move in the right direction."

In March 2006, BoJ had already "tapered" its QE, though in technical terms they changed the operating target of money market operations from current account balances (bank reserves) back to the uncollateralized overnight call rate still then at zero. Just like 2000, however, there was still a great deal of uncertainty about "deflationary pressures" in Japan. In 2004, the CPI had turned positive, seemingly confirming the solidness of the recovery; reaching as high as +0.8% in November 2004. But that was all short-lived, as just three months later in February 2005 the CPI was negative once more. By November of that year, it was down as far as -1.1% all over again as if QE hadn't changed anything since 1999.

To start 2006, the CPI was moving back up toward zero again allowing the voting committee to at least figure some evidence for QE's success beyond the same typically bland platitudes and assurances that are now largely boilerplate requirements.

"Japan's economy continues to expand moderately, with domestic and external demand and also the corporate and household sectors well in balance. The economy is likely to expand for a sustained period...The year-on-year rate of change in consumer prices is projected to continue to follow a positive trend."

These words should sound entirely too familiar to our American ears in 2016 (or 2015 for that matter). These respective economies are always continuing to expand moderately where risks are "well in balance", yet for all the happy talk even officials know well there isn't any more to it - but there really should be. Though the Japanese government reservations about the rate hike in 2006 was far more subtle, opposition was much more vocal this time from within. The 25bps increase in the target for the uncollateralized overnight rate in July 2006 passed with just six yes votes out of nine.

By early 2007, the CPI was back to zero and heading negative yet again. Despite that, the Bank overlooked it and a great many other gathering negatives to vote for a second hike in February 2007. Just like August 2000, the BoJ members had overseas concerns which they as always dismissed because of "continue to expand moderately."

"Uncertainties over the future course of overseas economies, including that of the United States, are abating, and this is likely to reinforce the prospects of continued increase in corporate profits and business fixed investment. With respect to private consumption, the weakness observed in the last summer seems temporary, and it is judged that private consumption is on a moderate increasing trend."

The one constant throughout Japan's experiment with an "independent" central bank has been how private consumption is always "temporarily" weak despite so much attention (and yen) paid to "aggregate demand"; the one constant with all these central banks following these policies is that problems are only "overseas" but somehow though constantly abating are sufficient to prevent any central banker from validating his policy by acting with true resolve. From this review of Japan's experiences with rate hikes and especially how eerily similar they are to the FOMC's fumbling over them today, it is entirely reasonable to suggest that these economist policymakers have very little grasp of how an economy, any economy, actually works.

That starts with grave misconceptions over money itself. The second rate hike of that series in February 2007, the last one BoJ was able to carry out, points out all the ways in which this is true. Just as then Fed-Chairman Ben Bernanke claimed "subprime was contained", BoJ staff actually thought "uncertainties" about "overseas economies" were "abating", even here in the US. There is no way to make such a statement, which spoke of only "uncertainties" not even outright weakness as was already apparent even in Japanese conditions by then, without misunderstanding completely bubbles and where they came from (and thus how they would end).

Central bankers just assume without evidence (regressions don't count, especially when constructed from dubious assumptions to begin with; GIGO) that QE equates to "money printing" and thus assign all economic measurements whether appropriate or not as confirming that "stimulus" is working. They are biased to their own work and thus are ever picturing its success. Every doubt as to whether there is any truth to the bias is characterized as "temporary" or "transitory" because they fully believe stimulus always works and that what they do is stimulus.

Analyzing their repeated failures, however, leaves one with the unshakable feeling that there is "something" far greater going on; a factor that central bankers don't ever seem to want to consider. They unleash this power and fury (in increasing quantities and methods, it needs to be pointed out) only to be thwarted time after time; worse, such that whenever they get to believing in their own success they can only ever do so by whatever exceedingly shallow diagnosis; again, very relatable to Janet Yellen's current predicament.

How can ZIRP and money printing be so feeble? There is a reductionism that is extremely important in all of this, starting with the premise of QE. A significant dose particularly those in the trillions should not leave policymakers straining to find evidence of its effects. That should be true in the intermediate term but undeniably so over the long run. The fact that none of these central banks are able to escape with clear achievement can only mean that either "something" greater than QE is holding it all back, or QE isn't "stimulus" in the first place. Both of those options lead to only one conclusion; central banks, the supposed masters of currency and money, don't know near enough about currency but especially money.

From that perspective, you can begin to understand why each is so often fooled by what is really positive spin - if you don't know money, you aren't as an agent of monetary policy going to know enough about the economy. The truth about so much of these questionable monetary circumstances is that they lead to a clear unevenness in economic function; alternating sometimes just month to month between what looks like onrushing recession with what appears to be just its opposite. Believers in orthodox "stimulus" cling to those positive months or short periods as essential proof while dismissing the equally (or more) frequent negative months as "transitory" because "stimulus" always works. And they are only ever thwarted for these assumptions.

The end result is an economy that goes nowhere, languishing in prolonged malaise seemingly caught in monetary limbo between perpetual recession and a recovery that intermittently appears to be just around the corner. It feels just good enough not be the worst case but also never completely breaking free of what feels like an unknown anchor. In the end, it is actually the worst of the worst cases, where the economy has been removed completely from the normal business cycle and left in indescribable, frustrating agony. This condition even has a name if but colloquial by design - Japanification.

"Japanification" is really nothing more than the sustained product(s) of grand monetary impropriety. From this point of view, monetary policy itself takes on a far different role. It is not and can never be "stimulus" but rather like shooting a flare into the dark night a warning signal about what is happening. In other words, "stimulus" is entirely reactive, with very limited abilities to be proactive in fashioning an effective response. Like an amoeba, central banks are what is reacting to stimulus by rolling out their responses that never seem to work. Therefore what central banks offer are not solutions to monetary problems but markers that there are these problems and they are serious.

The history of the last ten years of global Japanification or depression is a history of exactly that. Starting in early 2007, the global monetary system began to careen toward realizing its imbalances just as the BoJ was voting that it wouldn't matter. It so clearly did, a fact reflected in how global central banks officially signified the dark monetary condition not by fixing it but by being a helpless bystander to it. The more they struggled, the worse you knew it was getting; it was not a hopeful sign that policymakers were doing more, it was a foreboding one that they viewed "extraordinary" "tools" as "necessary." This was repeated all over again in 2012 (US, Europe, Japan, and China) and then once more in 2014 (Europe, Japan, and China). The great eurodollar events of the past decade are given official status by what they have made central banks do in response.

Japan pioneered this backward stance, but it is a global deficiency where ZIRP and QE were post hoc recognition that the economy was already in serious trouble. That the economy remains in serious trouble, now having gone on so long that serious social and political ruptures are forming, is testament to how little of money monetary policy appreciates. Perpetual Japanification, however, is not an option for the rest of the world because social stability is far too variable outside Japan.

If that was the end of it, there would be some hope along the lines of a true science seeking objective facts. Instead, what is far more important is that economists and central bankers don't ever learn, completely uninterested in any solution that doesn't preserve their own role. They have thoroughly proven that they will never abandon their view of money because that would mean disavowing themselves and everything they believe. With politically self-centered ideology their operating principle, we are left with only one use for them, to verify for us when the eurodollar is acting disruptively again. Quite fittingly, having finally abandoned QE, the BoJ in 2016 has been once again busy designing and offering more "stimulus" to prove all over what it had already established a decade ago.

It didn't receive much attention at the time, but last October before the FOMC voted for a first "rate hike" Nobuyuki Nakahara told Bloomberg in an interview, "I have no doubt they will end up repeating the same mistake as the BOJ if they raise the rate." Who is Nakahara? The BoJ Board member who voted against the rate hike of August 2000. He should know better than anyone central bankers don't repeat or even make mistakes, "overseas" turmoil or "transitory" factors always, always "somehow" snatch defeat from the jaws of victory. Unless the people act, some things will never change.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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