October 8, 1999

Listening to Mr. Hayami

By Michael Judge, an editorial page writer for The Asian Wall Street Journal.

Troubled societies often seek scapegoats, and in Bank of Japan Governor Masaru Hayami the Japanese have got one made to order. Unless you've been stranded on a desert island all summer, you probably know that the yen is surging, a phenomenon many believe could pull the rug out from under Japan's nascent recovery.

Yet much to the dismay of pundits who believe Japan's monetary policy remains too tight (near-zero interest rates and a 60 trillion yen bank bailout notwithstanding), Mr. Hayami has refused to loosen either by engaging in nonsterilized currency interventions or directly underwriting government bond issues. Some critics have even called for the central banker's resignation if he does not reverse his current stance.

That much is clear. What remains a mystery to some is why Mr. Hayami, the man who holds the purse strings on an important national currency, would willfully sabotage Japan's budding recovery. Surely Mr. Hayami would not allow the world's second-largest economy, Asia's "engine of growth," to choke and sputter to a grinding halt simply to save face? Has this seemingly refined and gentle 74-year-old central banker slipped quietly into senility?

The short answer is of course not. In fact, over the last year Mr. Hayami has plainly and repeatedly stated his position on monetary policy and what role it should play in Japan's economic recovery. If those who believe Japan can inflate (Paul Krugman) or export (Kiichi Miyazawa) its way to economic recovery are angry, it's not because Mr. Hayami's position has been unclear. Rather, it's because they refuse to accept the clear-cut message he's been delivering.

As far back as last spring, Mr. Hayami was telling the world what he thought of further demand-side economic policies. On March 18 he delivered a speech to the Research Institute of Japan in which he said, "If policies to stimulate aggregate demand continue to be implemented without any progress in structural reforms to renew the private sector, Japan's economy will become increasingly inefficient and its productivity will decline further. Such an economy would be vulnerable to shocks that could lead to vicious inflation. In order to achieve sustainable economic growth without people anticipating inflation, the private sector should be continually revitalized through innovations and expansion of business frontiers. One obvious example of this is the U.S. economy, which has enjoyed eight years of uninterrupted expansion."

In other words, the message the market is broadcasting is that Japan is using its resources inefficiently, not that monetary policy is too tight. The government needs to stop relying on exports and regulations to balance the distortions in its economy. Japan can only solve its economic problems by tearing down structural barriers and raising productivity. Mr. Hayami understands this message and with his current policy stance is attempting to pass it on.

While it may appear that Mr. Hayami is alone in his thinking, there are those who agree with his decision to hold the line. "Foreign demand is not the solution," says Marshall Gittler, head of Asian currency strategy at Bank of America. "The central bank should be applauded, not attacked, for wanting to, in the words of Mr. Hayami, 'Send the appropriate signal and give the right incentives to the public.'"

Indeed, Mr. Hayami may be the only policy maker in Japan with the guts to argue that pulling the same old Keynesian levers (i.e., ever-greater government spending and monetary easing), could actually hurt the economy by discouraging the creative destruction needed to increase productivity.

On July 27, the BoJ governor delivered a speech entitled "Challenges for the Japanese Economy." In it he noted that Japan's record low growth in the 1990s was most likely due to structural problems. "If this is the case, it is difficult to expect a long-lasting recovery, if any, based solely on macroeconomic stimulus measures. Hence, to restore vitality to the Japanese economy in the medium term, painstaking efforts must be made to resolve each structural problem so as to enable the nation's economic potential to fully blossom ... ."

To blossom, Japan's domestic firms must first become more productive. Japan's world-beating export industries, which were exposed to international competition, managed to stay on the cutting edge of productivity and accordingly could pay higher and higher wages. Less competitive industries had to pay higher wages too to keep up. "They could afford to do so by passing their costs along," explains Bank of America's Mr. Gittler, "thereby becoming even less competitive, and then hiding behind a variety of barriers that kept out both foreign competitors and new domestic ones."

With the onset of globalization and deregulation, however, this growth mechanism has become unsustainable. This, says Mr. Hayami, "should be regarded as one of the most difficult structural problems facing the Japanese economy. Crucial for Japan's economic future is how to raise the productivity of industries which have not operated in a competitive environment."

Is there a heretic in the midst of Japan's devout Keynesians? It appears so -- at least to a degree. And this may be the real reason Mr. Hayami has come under fire by the tax-and-spend politicians of Japan's ruling Liberal Democratic Party. While monetarists may actually believe that Japan is in the clutches of a deflationary spiral that can only be broken through expanding the nation's money supply, the LDP, rest assured, is not thinking that far ahead. The party has managed to hang on to power, despite making a shambles of the economy, mainly by shoveling taxpayer money into the pockets of its constituents in the banking, real estate and construction industries.

Now, with government debt surpassing 100% of GDP, Prime Minister Keizo Obuchi and his enablers in the Ministry of Finance are pressuring the BoJ to open the floodgates for more government spending by directly underwriting government bond issues, essentially monetizing the national debt. Such a policy would give Mr. Obuchi and the LDP a blank check for further fiscal stimulus. With government debt already at dizzying levels, Mr. Hayami has refused to do so on the grounds that it could lead to runaway inflation and, again, discourage reform.

Moreover, in a recent interview with Japan's Gendai magazine, Mr. Hayami said that if the BoJ were forced to underwrite government bonds they could be downgraded to junk status. "If it becomes easy to take money from the BoJ," he continued, "there is also the possibility that moral hazard would spread all over Japan and that economic structural reform would be delayed."

Mr. Hayami is right to identify Japan's problems as structural not cyclical. But his concern about spreading moral hazard throughout the economy sounds a bit disingenuous, considering the fact that the central bank is pumping up the private sector by soaking up trillions of yen in commercial paper and corporate bonds.

According to Jesper Koll, chief economist of Merrill Lynch Japan, the BoJ's total assets have expanded dramatically in the past year and are now equivalent to 20% of private bank assets. Meanwhile, the Obuchi administration is guaranteeing every loan that comes its way. Amazingly, more than 10% of private loans are now guaranteed by the government.

Mr. Hayami is a central banker and central bankers are supposed to keep their eye on price stability. However, the fact that the BoJ's already super-loose monetary stance has failed to substantially increase Japan's money growth demonstrates his points about structural impediments. The animal spirits of the Japanese economy will not be unleashed by unimaginative fiscal and monetary stimulus. To increase the nation's demand for money, Japan needs to broaden its tax reforms that took effect on April 1 and further deregulate key sectors, even if the result is a stronger yen. Mr. Hayami seems to understand this better than anyone else in a position of authority in Japan.

--From The Asian Wall Street Journal

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