by Gary North
It has finally happened. The Bank of Japan, Japan's central bank, has begun purchasing stocks held by the nation's commercial banks. The BoJ creates digital money to buy the shares. The shares now in the BoJ's possession serve as legal reserves for the expansion of Japan's money supply.
This has begun to move the monetary system from credit money to pure fiat money. The ability of the central bank to expand the money supply will no longer be limited by people's willingness to borrow. Now the only limit will be the willingness of sellers to sell. In a time of economic slowdown and a premium on cash, there are few limits on hard-pressed sellers' willingness to sell.
The first effect of this increase in the money supply is this: commercial banks will spend the money they have received from the BoJ. Money created is money spent. Money does not sit idle in any bank's account. Banks make money by lending money or by buying assets, such as government debt. If a low-risk asset pays anything above zero, the bank will buy it if there is no better opportunity. Better something than nothing; better a little income than no income.
When the bank buys an asset from someone, the asset's seller becomes the owner of newly created money. He spends it or invests it or deposits it in his bank. So, the money is passed from buyers to sellers. It will stay in circulation. It will remain in someone's bank account.
The second thing that happens when the BoJ purchases equity is that the commercial bank gets rid of a depreciating asset, or a high-risk asset, and transfers it to the BoJ.
Japanese banks are unable to meet the capital requirements that were imposed in 1988 at the Basle Accord. The richest nations, known collectively as the G-10 nations, agreed to higher capital requirements for their commercial banks. This was a year before the Japanese economy peaked. Japanese banks are allowed to use the value of stocks in their portfolio to count as part of their capital requirements. The Japanese stock market was a bubble in 1988. The shares were rising. Japanese banks had money to lend because their capital looked secure.
Beginning in January, 1990, the Japanese stock market started down. It has never again approached the December, 1989 high. Bank capital therefore began to shrink at the same time that poor real estate loans ceased to produce interest income. Japan has never been able to meet the Basle Accord's timetable. But Japan is too big to fail. There is no way for the other nations to impose meaningful sanctions on Japan for not enforcing the Basle Accord.
Over 100 countries have formally adopted the terms of the Accord. Predictably, only a handful of them have actually met the Accord's requirements, which are restrictive in the expansion of money in a fractional reserve banking system. When banks slow their lending because they have hit legal restrictions in the form of capital requirements, economies that have been growing cease growing. This is politically unacceptable to politicians and central bankers.
Policy-makers want the benefits of a pure gold coin standard — stable prices, no boom-bust cycle — but without the political restrictions of a gold standard: public control over the money supply through bank runs in gold coins, the inability of governments to sell lots of new bonds to banks without raising interest rates, and economic growth determined exclusively by factors in a free market. A gold coin standard is the mark of decentralized control by individuals over the economy. Politicians and central bankers resist this development.
So, we see the authorities on a tightrope. They do their best to avoid mass inflation, but they also want to avoid deflation and recession. Their prior policies of monetary expansion created a politically popular economic boom. New policies designed to keep prices from rising threaten to stop the boom.
THE SITUATION IN JAPAN
In Japan, the economic boom stopped in 1990 and has never reappeared. Japan's commercial banks have been trapped in a tightening noose. Their Basle-imposed capital requirements have risen at the same time that the market value of their capital has been falling: bad real estate loans, falling share prices, and bad industrial loans.
This has led to a refusal of the commercial banks to lend to innovative small companies, which are the basis of most economic growth. These companies find it difficult to sell shares because of the normal regulatory process, but also because of falling share prices. The result has been a lack of economic growth. The Japanese economy has been staggering for over a decade. It gives few indications that it is ready to rebound.
Japan's aging public has lost faith in the system. Voters are not agreed on what needs to be reformed, so the government changes nothing of substance. It just does more of the same. It spends more money. It runs large deficits. The debt burden per capita rises continually.
Japan has become the world's strongest piece of evidence that the Keynesian policy of economic growth through deficit spending does not work well. The Japanese economy does not recover despite 13 years of deficits.
The central bank has expanded the money supply in order to keep the general price level from falling. It has reduced short-term interest rates almost to zero. Still, the economy refuses to improve. The stock market continues to fall. The nation's investors, which includes the commercial banks, have lost faith that the stock market will ever return to its 1989 level.
All politicians fear price deflation, which is regarded as the chief mark of recession. Debts that were voluntarily contracted when prices in general were higher become an increasing burden on debtors when prices fall, i.e., when the value of money increases.
The other side of the coin is also true. When prices in general fall, this is good news for creditors, who experience a windfall profit: rising real income. But there is a politically inescapable rule: don't alienate debtors. Politicians understand this rule and follow it: "There are more debtors who vote than creditors who vote." It is a political liability to be an incumbent when prices in general are falling, unless the fall in prices is being produced by rising output. Even then, there are political liabilities. Debtors want a return to the good old days of rising prices, thus enabling them to pay off their debts less expensively. They vote for politicians who promise them depreciating money.
Officials with the Ministry of Finance, an agency of the government, recently called on the Bank of Japan to increase the money supply enough to create at least 3% price increases per year. The Japan Times (Dec. 3) reports:
The Bank of Japan should set an explicit inflation target of 3 percent to beat deflation, two senior officials of the Finance Ministry wrote in a joint article in the Financial Times on Monday.
"The BOJ would have to adopt innovative, nontraditional antideflationary policies," said Haruhiko Kuroda, vice minister, and Masahiro Kawai, deputy vice minister, for international affairs at the ministry.
"These should include an explicit inflation target of 3 percent to be achieved in stages — such as 1 percent inflation within a year, and 2 percent to 3 percent within the following two years," they said.
Toward this end, the BOJ should buy long-term government bonds and other financial instruments to provide more liquidity to the market and constantly increase base money, the article said.
This announcement comes in the middle of one of the most stupendous periods of peacetime monetary expansion in history for any modern industrial nation. Click through and look at the charts for Japan's Adjusted Monetary Base, which has fallen from about 33% per annum to a "mere" 21%. The M-1 money supply has risen in this period from under 5% per annum in late 2000 to over 30% in the most recent report.
This has drastically reduced interest rates: the supply of money is increasing in the face of borrowers' resistance to take on more debt. Government bonds return a little over 1%, and the 3-month CD rate is barely above zero percent.
What must be bothering the Ministry of Finance is the M-2 growth rate. It is a little over 3%, up from less than 2% in 2000. The M-2 aggregate includes the public's savings deposits in banks.
The Japanese public is exchanging bank accounts for currency. Currency pays no interest, but it is safe from a bank default. In fact, widespread bank defaults would produce a premium price for currency. "A bird in hand is worth two under the bush." The lower that bank account interest rates go — now barely above zero — the less expensive it is for depositors to switch from a savings account to currency.
Prices are falling slightly in Japan. The huge discrepancy between M-2 and M-1 growth indicates that there is a quiet run on the banks: the exchange of savings accounts for currency. Cash is emperor in Japan. In a nation filled with people who don't use credit cards and who prefer currency, there is a lot of slack in between the Adjusted Monetary Base and M-2. So, conclude the two officials,
"Aggressive monetary reflation is needed most in Japan," they said, adding that it would help prevent the accelerated pace of bank and corporate restructuring from imposing further deflationary pressure on the economy.
Kuroda and Kawai also proposed that a "concerted global reflation" policy be pursued by the central banks of the United States, Europe and Japan to minimize the risk of a delay in economic recovery and price deflation globally.
"A tripartite strategy for global reflation would bring major benefits to the world economy with minimum cost," they said, adding that China should also be involved because it, too, is undergoing price deflation despite high growth performance.
I love that last phrase, "undergoing price deflation despite high growth performance." This makes high economic output sound like a negative factor. It is if the public is sitting around, hoping and praying for (say) higher computer prices. "Save us from discounts!" Keynesians do not admit that falling prices, when they are the result of rising output, move the world away from scarcity in the direction of greater wealth for all.
Japan's problem is not falling prices through rising output. Rather, its problem is falling prices due to a contracting economy, i.e., a shrinking division of labor. The central bank-funded boom economy has turned into a bust.
RE-LIQUEFYING THE BANKS
At the end of November, a new era began in Japanese central banking. To the extent that "the Japan disease" spreads to other Western countries, so will the proposed cure spread. The proposed cure is the monetization of equity. The Japan Times (Nov. 30) reported this.
The Bank of Japan began buying shares held by banks Friday, taking on increased risk in a bid to help banks unwind cross-held shareholdings with borrowers.
Mitsui Trust Holdings Ltd. and a group of unidentified banks asked the BOJ to purchase several billion yen worth of stock by the end of the day, the central bank said.
The purchases are part of the BOJ's plan to buy up 2 trillion yen worth of commercial banks' shareholdings by September 2004.
Banks hold large amounts of stock issued by their biggest corporate clients, a legacy of Japan Inc. With cross-shareholding, banks shielded companies from irate stockholders and corporate takeovers and allowed them to carry through with long-term projects.
Those stock holdings have slumped and are one of the major threats to bank capital, resulting in over 2 trillion yen in unrealized portfolio losses in stocks and bonds at the end of September.
The two-trillion yen figure is not so great a number as it appears. Two trillion yen are worth less than $20 billion. Therefore, I regard this as a token purchase. What does this token accomplish? It sends a message to the investing public in Japan and also the world of central banking. This message is simple: "There's more where that came from." If the BoJ thinks that commercial banks are in danger because of falling capital ratios due to falling share prices, it will intervene to solve the problem.
This policy means that the Basle Accord is a dead letter. It has always been a dead letter, as all such accords are in a world without a world government. A central bank can increase the domestic money supply at any time, and thereby inflate the domestic economy, even in the face of "tight" international capital requirements for commercial banks. Central banks can relieve pressure on their countries' commercial banks by monetizing bank equity.
Corporate shares are easy to monetize. There is a market for them, even the high-risk, low-profit stocks on the JASDAQ, the equivalent of the NASDAQ. Have no fear; the Bank of Japan is here!
The government requires banks to reduce the balance of their shareholdings to a point equal to or lower than their core equity capital by the end of September 2004. The BOJ has offered to buy up shares exceeding this amount.
All of Japan's major banks have signed up for the stock purchase program, with the exception of Sumitomo Trust & Banking Co., which has already met the government's shareholdings requirements.
But what about the quality of the portfolio of the Bank of Japan? The article continued:
The day before the purchases, BOJ stocks on the Jasdaq over-the-counter market fell to a 16-year low, reflecting concerns over how the purchases might damage the quality of the central bank's assets.
But what does it matter what the quality of assets is? If the central bank is not only the lender of last resort, but also the buyer of last resort, then all assets have a potential market. If the central bank is buying any category of assets, then existing holders of these assets can cash out of their investments at any time. The point is, the quality of any asset is measured by its liquidity, and if the central bank is a buyer of last resort, then everything deserves a AAA rating by Moody's — everything except the yen. This leads me to North's law of junk investing:
"When you can sell junk assets to the central bank for cash, then cash becomes junk."
In the ongoing debate between those predicting price inflation and those predicting price deflation, the theoretical issue of the monetization of equity should not be avoided. This is because monetary theory has turned into monetary policy in Japan.
There are real inflationists out there: policy-makers who recommend monetary inflation in order to produce price inflation. There is not one visible policy-maker on earth who recommends price deflation as a way to re-structure capital values in terms of the new, post-inflation economy. The entire world is a bubble economy, yet there is not one public official with any influence who calls for central banks to stabilize money, refrain from interfering in the money markets and debt markets, and allow commercial banks to sink or swim in terms of free market competition. To recommend such a policy of non-interference is to recommend the transfer of economic authority away from the central bank to the investing public, including bank depositors. The central bank, beginning with the Bank of England in 1694, was invented in order to thwart the economic authority of the individual investor-depositor.
The monetization of debt is the central bankers' pay-off to the national politicians who chartered the private central bank as a quasi-government agency. If necessary, there will be additional pay-offs to any organized financial group that has sufficient political clout to be a threat to central bank's monopoly over money.
A central bank is designed to achieve two primary goals: (1) provide loans to the government; (2) to protect commercial banks from depositors who might become part of bank runs.
There is a third goal, which was tacked onto central banks during the Great Depression: to provide sufficient credit money to persuade consumers to keep spending, thereby keeping the economy growing. This is the area of agreement among all schools of economic opinion except the Austrian.
This is why a central bank will not find resistance when it adopts the policy of monetizing equity. Owners of assets want to bring buyers with money to the national auction when the owners decide to sell. There is nothing like a central bank's digital printing press to assure sellers that buyers will have money to bid at the auction.
There isn't going to be long-term price deflation until after the mass inflationary crack-up boom has taken place, i.e., the collapse of bank money's value. This boom era will be the junk money stage. Until it ends, would-be buyers of goods and services will get access to money. If they refuse to borrow, therefore refusing to spend, then there will be a buyer of last resort: the central bank.
The reverse Midas touch will continue: turning junk assets into junk money.
December 14, 2002
Copyright © 2002 LewRockwell.com