Matthews Asia’s Taizo Ishida ponders Japan: A sense of déjà vu?

Taizo Ishida, portfolio manager at Matthews Asia, says Japan faces a historic monetary policy shift, but only if the right person is appointed to lead the Bank of Japan.

Considering the recent rise in Japan’s equity markets you may be forgiven for thinking that the recent policy announcement of setting a 2% inflation target is as good as a done deal.

Many investors, however, remain skeptical that the policy set by Japan’s Prime Minister Shinzo Abe and outgoing Bank of Japan (BOJ) Governor Masaaki Shirakawa is actually achievable. To be fair, history is on their side.

The BOJ’s “reflation policy” has failed to raise CPI above 1% for more than 15 years – with the exception of 2008 when global commodity prices reached a record high. The problem has not been due to a lack of activity from the BOJ. The now all-too-common quantitative easing policy was practically invented by the BOJ in early 2000s and the bank has been pumping money into the economy ever since. Rather, the issue is more one of long-term commitment and “quantity.”

A prime example is February last year, when the BOJ took the bold action to explicitly state it would target a 1% inflation rate. Over the course of a few weeks, the US dollar appreciated about 11% against the yen as market expectations of further easing increased. However, true to form, the BOJ came up short, limiting the size of their action and failing to hit the target.

So could this time be different?

In my view, it just might be. Taking a look at the current weakness in the yen, I see two key reasons for it.

The first is Abe’s new initiative to improve the economy by taking aggressive fiscal and monetary action.

The second, and perhaps most important reason, is the impending appointment of a new BOJ governor, to be named by April, who may fit a “Ben Bernanke” mould, particularly as Shirakawa’s recently announced decision to end his term earlier than expected may boost efforts at more aggressive monetary easing. The future direction of the yen could hinge on this appointment.

If we consider the BOJ’s activity during the Global Financial Crisis we can see why this appointment may hold so much significance. After the fallout from the Lehman Brothers bankruptcy in 2008, troubles spread quickly from the US to Europe. The relatively small exposure Japanese banks had to toxic derivatives was supposed to be enough to keep its economy immune from the problems developing overseas. However, Japan was ironically one of the worst affected economies. This decline was not due to the health of its banks (which last year emerged as top lenders of the Asian debt market), but rather due to the strength of the yen.

Post-Lehman the world’s central banks embarked on a vast asset purchasing program to drive down yields and in turn, currencies in order to support domestic economies. Meanwhile, a lack of commitment by the BOJ to implement sufficient quantitative easing helped allow the yen to rise against global currencies, making exports less competitive and sending the economy into recession. A cheaper yen could have boosted exports and supported domestic companies in Japan.

To further understand this, one only needs to look at how central banks have grown their balance sheets since 2007. By comparison, the BOJ’s balance sheet has hardly changed.

That aside, I do believe the dovish rhetoric in recent weeks holds some substance and the current weakness of the yen and stock market rally could be sustainable over the short to medium term. However, in my opinion, investors should ignore all the political hype and noise around “Abenomics” and pay more attention to the appointment for BOJ governor. With the right candidate, things really could be different this time around.

 

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