TOKYO – Global markets are experiencing two firsts for Japanese Prime Minister Fumio Kishida.
One, Kishida surprised the investment world for the very first time in 16 months leading Asia’s No 2 economy. Second, he appears to be making a smart staffing choice by favoring Kazuo Ueda to lead the Bank of Japan (BOJ).
By going with a candidate virtually no one had on their possibilities list, Kishida has markets buzzing about whether Tokyo is finally plotting an exit from 23 years of zero interest rates.
Almost without exception, all of Kishida’s cabinet choices to date have been from central Liberal Democratic Party (LDP) casting. That means a sea of risk-averse, 60-something, overwhelmingly male lawmakers chosen for links to various political factions and regions, not skill or vigor.
Can you name Kishida’s finance minister without using Google? No worries, many Japanese don’t know Shunichi Suzuki either.
Everyone knows the retiring Haruhiko Kuroda and his backstory, though. The reason is that the BOJ has been essentially managing the economy while governments come and go. None more than Kuroda, who spent the last 10 years supersizing the BOJ’s balance sheet.
Now, everyone is racing to get up to speed on Ueda, who Kishida is expected to tap formally this week. Economist Krishna Guha at Evercore ISI speaks for many in calling Ueda “an enigma to markets.”
Adds Brent Donnelly, president of Spectra Markets: “Everyone is confused, chasing theories like cats chasing a laser.”
Ueda is a solid choice by all indications. The Massachusetts Institute of Technology PhD served on the BOJ policy board between 1998 and 2005. It was a contentious period, back when then-governor Masaru Hayami pioneered quantitative easing (QE).
Not only was Ueda there at ground zero when the BOJ devised the policy that still dominates today, he was an independent voice. Ueda was a no-vote when Hayami decided to hike short-term rates prematurely in August 2000 (a move the BOJ had to reserve).
Ueda’s apparent aversion to groupthink may stem from his MIT training. After all, Ueda was a pupil of Stanley Fischer, the former Federal Reserve vice chair and No 2 official at the International Monetary Fund (IMF).
Fisher taught former Fed chief Ben Bernanke, former European Central Bank head Mario Draghi and former Treasury secretary Lawrence Summers. Other members of the MIT gang: Reserve Bank of Australia Governor Philip Lowe and former Bank of England governor Mervyn King.
“Ueda seems a very different type from Kuroda, in terms of being an academic who would plainly conduct policy based on actual economic fundamentals and value conversations with the market,” says economist Hiroaki Muto at Sumitomo Life Insurance Co.
Last week, Summers called Ueda “Japan’s Ben Bernanke.” Not only did Ueda and Bernanke have the same thesis advisor, but they homed in on similar areas of econometric specialization. One key point of intersection: the lessons from the Great Depression, including Japan’s late-1920s to mid-1930s policies.
For Ueda, that meant a keen focus on the exploits of economist Korekiyo Takahashi, who’s often referred to as the John Maynard Keynes of Japan. In the 1920s and 1930s, Takahashi served as finance minister, BOJ governor and even prime minister.
Takahashi is best remembered for a hyper-aggressive mix of monetary easing and aggressive fiscal expansion along with efforts that modern economists would call debt monetization.
Central banks buying ginormous blocks of debt directly from the government is as radical as any Group of Seven nation can get.
Many would say Takahashi ran the 20th century’s biggest experiment in so-called “Modern Monetary Theory.” All the debating over so-called MMT ignores that Takahashi effectively pioneered it. MMT holds that a country issuing debt in its own currency can borrow aggressively with little financial fallout or risk of default.
Bernanke once told an audience that “Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies.” In 2013, when the late prime minister Shinzo Abe hired Kuroda, Abe said the “example of my forerunner Takahashi has emboldened me” in the battle against deflation.
It hasn’t worked, of course. Yes, Japan is getting the biggest inflation surge in 40 years. Not because of a BOJ-driven boost in wages and consumption, but rather due to Russia’s Ukraine invasion, which has Japan importing commodities at elevated prices with a weak yen.
As Kuroda prepares to vacate his office in April, he has little to show for growing the BOJ’s balance sheet to a size bigger than Japan’s US$5 trillion economy. The Kuroda era pushed the BOJ so deep into governments and the stock market that it’s now effectively trapped.
That was clear enough on December 20 when Team Kuroda announced the slightest of tweaks imaginable: letting the yield on the 10-year bond to go as high as 0.5%. Global markets had a mini-panic and the yen skyrocketed as traders assumed the BOJ was signaling an end to 23 years in the QE zone.
Not so fast, the BOJ retorted. It spent the following few weeks doing huge, and unscheduled, asset purchases to cap the yen and to remind the globe that rumors of a massive BOJ pivot were vastly exaggerated.
Still, an exit is needed. Two-plus decades of being the key economic engine via zero rates deadened the nation’s animal spirits. Corporate CEOs have been disincentivized to innovate, restructure and take risks.
Government officials sat back and let the BOJ’s 24/7 ATM service take the lead. In the interim, Japanese government bonds (JGBs) have only grown in popularity, leaving everyone exposed.
If JGB yields jumped to 2%, banks, companies, local governments, pension and insurance funds, universities, endowments, the giant postal system and retirees get hurt.
It’s left a “mutually assured destruction” dynamic that dissuades virtually anyone from selling debt. The more JGB yields ratchet higher, the more difficulty Tokyo will have servicing the developed world’s biggest debt burden, now running at roughly 265% of gross domestic product (GDP).
Kishida’s first choice for the job, BOJ Vice Governor Masayoshi Amamiya, reportedly declined. The epic task – and unenviable challenge – will now likely fall to Ueda.
Unwinding 23 years of free money in a nation now hopelessly addicted is a task that few would relish. Even Kuroda, who still has considerable clout in Tokyo political circles, hasn’t dared to hint that QE is ending.
“FX traders view Ueda as a solid pick who is not as dovish as Amamiya potentially could have been,” says analyst Edward Moya at OANDA.
Yet politics will be a bigger variable for Ueda than many investors seem to realize. The BOJ, it’s worth remembering, is less independent than, say, the Fed or ECB. The powerful MOF has a seat in the room when BOJ officials make interest rate decisions.
Take, for instance, the events of December 20. The minutes of that meeting of BOJ policymakers show that government officials on hand asked for, and were granted, a half-hour break to consult their ministries.
That was for an incremental turn of the monetary screws. Imagine the pushback from government officials if Ueda tries to end QE, never mind execute a formal rate hike.
From the start, Ueda will be haunted by Toshihiko Fukui’s experience in the mid-2000s. In 2003, Fukui succeeded QE creator Hayami and set out immediately to exit QE, which he did in short order. In 2006, he pulled off Japan’s first rate hike in more than five years and then a second in early 2007.
Japan Inc was livid, and the nation’s financial empire struck back. Only Paul Volker, the 1970s-80s US Fed chairman experienced greater pushback. By 2008, Fukui was replaced with a BOJ leader who promptly slashed rates back to zero. In 2013, Kuroda pushed Japan’s QE further into uncharted territory.
Ueda is thought to be a pragmatist. While he’ll seek an exit strategy for QE, he’s well aware that Japan isn’t ready for a powerful yen surge. That would dent corporate profit margins in ways that give CEOs even less confidence to raise wages and catalyze a virtuous cycle of increased demand.
It would also hurt Japanese competitiveness vis-a-vis China. Arguably, this balancing act is second to none in global central banking circles.
Complicating things, Kishida’s approval rating is now in the mid-20s, a red alert danger zone for Japanese leaders. It’s not clear how soon a new government might come to power — and what its priorities might be.
Given the MOF’s influence at BOJ headquarters, Ueda will in some ways be captive to how much autonomy the prime minister and his cabinet afford it. Otherwise, lobbying will be intense to get members of Ueda’s policy board to vote against any hawkish pivot.
What’s needed is for government officials and the BOJ to cooperate more boldly. Kishida’s government – or the next one – must make moves to cut bureaucracy, liberate labor markets, incentivize innovation, increase productivity, shift tax policy toward startups and empower women.
Abenomics flopped because neither Abe from 2012 to 2020 nor his two successors met the BOJ halfway. The good news is that Ueda knows that Japan’s inflation is more about external events than anything the BOJ can control.
Economist Takeshi Yamaguchi at Morgan Stanley MUFG finds great significance in a July 2022 op-ed Ueda wrote for Nikkei Asia arguing that “the current rise in Japan’s inflation is largely driven by a negative supply shock from global increase in food and energy prices.”
Therefore, Ueda wrote, “a rushed hike of the interest rate in response to the inflation rate temporarily exceeding 2% is likely to adversely affect the economy and inflation rate and hinder realization of the goal of raising the interest rates by a sufficient amount over the longer term. This situation brings back memories of BoJ’s interest rate hikes in 2000 and 2006 not lasting very long.”
As such, Yamaguchi says, “we think the BOJ’s existing stance of emphasizing wage growth will remain unchanged.”
Economist Stefan Angrick at Moody’s Analytics adds that “with demand-driven price pressure still preciously scarce and stronger wage gains yet to materialize, it’s hard to see the BOJ rush towards tightening under a new governor.”
Even so, something needs to change at the BOJ — either to get more traction from its policies or to phase them out. Ueda seems like just the man to do it at just the right time.
Follow William Pesek on Twitter at @WilliamPesek