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Monday, May 3, 2004


Will intervention-happy BOJ see new risks as danger or deja vu?

Bank of Japan Gov. Toshihiko Fukui has entered his second year at the helm of the central bank, and in an economic climate radically different from the time when he first took up the job.

How has he handled the job over the past year?

On April 28, 2003, the benchmark Nikkei average on the Tokyo Stock Exchange hit a post-bubble low of 7,607.88. Confronted with the dire condition of Japan's economy, symbolized by its sluggish share prices, Fukui apparently had no choice but to continue with the ultra-easy monetary policies of his predecessor, Masaru Hayami, and had little room to introduce new ideas and new policies. At the same time, Fukui apparently won some support both at home and abroad for the soft-spoken manner he used to explain the positions of the central bank.

One thing I want to point out is that Fukui continued to supply the funds necessary for the massive dollar-buying intervention conducted by the Finance Ministry, whose arsenal has expanded to as high as 30 trillion yen. Although the effectiveness of such an interventionist policy has been widely doubted both inside and outside Japan, Fukui supported the dollar-buying activity, saying it was not inconsistent with BOJ monetary policy.

The BOJ under Fukui raised the target for the outstanding balance in the current account, maintained in the central bank by private-sector banks, to between 30 trillion yen and 35 trillion yen -- a move aimed at injecting more liquidity into the financial system. However, the increased liquidity was largely the product of currency market intervention -- attributable more to acts by other parties than by the BOJ's autonomous decisions.

In this sense, the massive intervention is in fact consistent with monetary policy, but we must not forget that it has brought about two new risks for the BOJ.

One is the deteriorating quality of the BOJ's balance sheet, which has ballooned to 150 trillion yen -- equivalent to roughly 30 percent of Japan's gross domestic product. Given that the corresponding figure is 12 percent at the European Central Bank and 7 percent at the U.S. Federal Reserve, it is apparent that the BOJ's balance sheet is much too much bloated. Its capital meanwhile stands at 5.3 trillion yen, which represents a state of extreme undercapitalization.

The other is that, as a result of this massive intervention, Japan's foreign-exchange reserves have topped $800 billion -- a risky asset that could end up putting a huge burden on taxpayers in the future. Even though the euro appreciated against the dollar faster than it did against the yen, the ECB balked on intervening in the market because it was aware of this very risk. Even so, the ECB had to report losses due to the declining value of its U.S. dollar holdings.

The BOJ is now being confronted with these two risks to the Japanese economy, and they cannot be justified simply in the name of division of labor with the Finance Ministry.

Then what do we expect of Fukui? As mentioned in a recent Group of Seven statement, it is obvious that his primary task is to appropriately steer Japan's monetary policy in the current phase of Japan's economic upturn, which is being symbolized by the recovery in share prices. The recent congressional testimony by Federal Reserve Board Chairman Alan Greenspan was closely watched because there are strong expectations that he may start tightening monetary policy amid the upturn in the U.S. economy. In Japan, however, there is strong pressure for the BOJ to maintain its easy monetary policy, given the continued weakness in small businesses and rural economies.

But we must not forget that there's a negative aspect to continuing an ultra-low interest rate policy -- providing protection to those unable to survive the intensifying economic competition in and outside the country.

The so-called "shuttered street" phenomenon, in which stores lining the main shopping arcades of rural Japanese cities and towns are seen closed and locked up, is the result of this local inability to adequately deal with competition from large discount supermarket chains. There is no reason why small local stores, lacking parking space and selling the same products as chain stores but at higher prices, should attract the increasingly motorized consumers in this country. Even the children of shop owners are hesitant about taking over the family business.

The main reason for their decline is a failure to adapt their ways to the changing business environment. This is the limit of what monetary policy can do. On the other hand, a number of municipalities have succeeded at reviving their economies with redevelopment projects and unique products.

It is still fresh in our memories how the BOJ's failure to promptly hike interest rates in the late 1980s -- after the post-Plaza Accord decline of the dollar necessitated the use of an easy monetary policy -- gave birth to Japan's infamous economic bubble.

At that time, the BOJ was well aware the Japanese economy "sits on dry firewood." But it still failed to tighten monetary policy quickly enough, thereby planting the seeds of the economic woes that continue to plague us today.

Gov. Fukui was one of the members who took part in the central bank's policy decisions at that time. I hope he doesn't make the same mistake twice.

Teruhiko Mano is a professor at Seigakuin University.

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