Conflict threatens to destabilize yen and delay end of easy money

William Pesek

April 09, 2018

Bank of Japan Gov. Haruhiko Kuroda is in for a new set of worries in his second term.

Let us sum up Haruhiko Kuroda’s first term at the Bank of Japan in two words: deflationary mindset. In 2013, Tokyo’s central bank chief set out to end decades of deflation via a monetary jolt the likes of which markets had never seen before.

But two very different words may dominate his new term, which starts today: Donald Trump.

In recent weeks, Gov. Kuroda dropped hints his policymakers are charting an exit from history’s most aggressive quantitative-easing program. Talk of “BOJ tapering” replaced bets that Kuroda might go the other way, taking steps to cap a surging yen and protect exporters.

The about-face in market perceptions is premature, though, as the U.S. president swings a wrecking ball at the global economy. Trump’s weak-dollar policy, escalating trade war and capricious decision-making complicate Tokyo’s reflation efforts. Every challenge Kuroda thought he understood has been replaced by uncertainty emanating from Washington.

The BOJ’s latest “tankan” survey showed weakened sentiment at Japan’s biggest manufacturers for the first time in two years. It is no coincidence that, in the three months to March, the White House declared dead Washington’s 23-year preference for a rising dollar (the yen has gained 5% this year). And now Trump has dusted off the playbook of the Smoot-Hawley tariffs of the 1930s and begun slapping duties on imports, somewhat indiscriminately.

First, it was 25% on steel and 10% on aluminum. Then Trump announced plans to impose tariffs on $50 billion worth of Chinese imports — everything from heavy machinery, airplane parts, batteries, semiconductors, motorcycles, you name it. And later Trump ordered officials to draw up another $100 billion tariff action plan. So far, China has retaliated quickly and assertively, imposing $50 billion of duties on U.S. products. Going toe-to-toe, President Xi Jinping displayed a readiness to sustain significant short-term pain to counter the “America First” president.

This escalating tit-for-tat between Tokyo’s two main trading partners puts the BOJ in a tough spot.

Kuroda began 2018 in a pro-exit mood. With Japan enjoying its second-longest postwar expansion and corporate profits buoyant, Kuroda hoped his second term would be about normalizing monetary policy. A Reuters survey last month found that 74% of companies polled agreed it is time Kuroda & Co. withdrew from markets, starting with reducing its 80 trillion yen ($747 billion) worth of annual bond purchases.

Several headwinds have emerged since January, almost all of Trump’s making. The most obvious warning sign is a sliding Nikkei Stock Average. After rallying 19% in 2017, the Nikkei is following U.S. shares into the red, falling 5% so far this year. Trump’s intensifying trade war and fitful tweets are countering optimism about December’s $1.5 trillion tax cut. The chaos also clouds the outlook for wages.

This, after all, was supposed to be the year Japan Inc. finally gave a critical mass of workers a sizeable raise — 3% or more. A dearth of generous increases explains why five years on, the BOJ is only about halfway to Tokyo’s 2% inflation goal. The tankan downshift — by two points — suggests Trump’s assault on the global trading system may be cowing corporate chieftains. And that changes the calculus for Kuroda’s team.

On April 3, Kuroda tried to keep his options open. He told parliament that “internally, we are conducting various discussions” about an eventual exit. Yet the stock market is puzzle. Recent data make clear that without record central bank stock purchases, the rout would be much worse. Kuroda’s team bought $7.8 billion worth of exchange-traded funds in March, its biggest splurge since late 2010.

Since the start of Abenomics in late 2012, the BOJ has been a bigger buyer of stocks than foreign investors. Overseas money initially poured in as Prime Minister Shinzo Abe raised corporate governance standards. As foreigners leave, the BOJ’s role as stock sugar daddy becomes all the more visible — and troubling.

By the end of 2017, the BOJ held about 75% of ETFs, making it seem as much like a hedge fund as a monetary authority. The BOJ cannot prop up the equity market of the world’s No. 3 economy in perpetuity. It cornered the government bond market to such an extent — owning 44% of it — that on certain days, nothing trades. On March 13, for example, the 10-year bond failed to change hands even once.

All this presents Kuroda with a Catch 22. Any hint he is reducing debt purchases would send the yen sharply higher and boost bond yields. The former would slam exporters and reduce prospects for wage gains. The latter would suddenly make Japan’s debt burden — more than two-and-half the size of the economy — harder to service. Yet pushing further into debt would distort secondary trading even more and make it harder to withdraw someday.

The same goes for ETFs. Try trimming holdings and the Nikkei and Topix indexes could crater, taking economic confidence down with them. Continue gorging and the BOJ looks like the People’s Bank of China. The PBOC has been known to load up on shares to stabilize prices, as it did in 2015.

Finding an exit in Tokyo is challenging enough in the best of times. It is even harder, though, with powerful crosscurrents from Washington. On the one hand, new Federal Reserve Chairman Jerome Powell is telegraphing three to four rate hikes this year. On the other, Treasury Secretary Steven Mnuchin wants a weaker dollar. Might a brawl break out between the Fed and Trump’s team — perhaps on Twitter? In Trump-adjusted terms, anything is possible.

Count, too, the ways Trump resurrecting the 1930s might bring Japan collateral damage. Back then, lawmakers passed the Smoot-Hawley Tariff Act. It turned a recession into the Great Depression. No serious economist expects an exact replay, but China’s forceful push-back could provoke Trump into additional own goals. Case in point: China’s ambassador to the U.S., Cui Tiankai, hinting that Beijing might consider scaling back on U.S. Treasuries purchases.

That would send the dollar sharply lower, adding to Kuroda’s plight. Tokyo, after all, owns nearly $1.1 trillion of Treasuries. Further yen strength would reinforce the deflationary mindset he sought to defeat.

Trump does not deserve all the blame. Before Trump’s inauguration in January 2017, Abe had 49 months to cut bureaucracy, deregulate industry, modernize labor markets, boost innovation and empower women. Big reform wins in any of these areas would have positioned Japan better for the forces now threatening the BOJ from across the Pacific.


William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He has written for Bloomberg and Barron’s.

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