The Federal Reserve is trapped in a cage made in Tokyo

As Federal Reserve Chairman Jerome Powell ponders how much leeway he has to raise interest rates, realities in Tokyo suggest the answer isn’t much.

In March, Powell’s team hit the monetary brakes for the first time in three years. This 25 basis point move came at a time when inflation is rising the fastest since the early 1980s. This has fueled expectations as there is a lot more tightening where this is coming from.

Yet the Bank of Japan’s difficult situation shows why the Fed by Powell may be more framed than investors appreciate.

Admittedly, the Fed and the BOJ are not ideal comparisons right now. But the BOJ pioneered the monetary sand trap that distorted the outlook for central bankers from Washington to Frankfurt to Sydney. And the fact that the BOJ is stuck at zero – and in quantitative easing mode – partly explains why the Fed Powell won’t tighten with the urgency that 8.3% inflation would seem to demand.

The common thread is how giant economies have gotten so used to nearly unlimited free money that they can’t imagine living without it. It has become the central banking equivalent of a public right.

Detox is something that Japan has never figured out how to do. The quick story is that the BOJ first cut rates to zero in 2000, an unprecedented act of a Group of Seven economy. In 2001 Masaru Hayami, then BOJ Governor, invented modern QE .

The problem is that the BOJ can’t find an exit. It kept the monetary engine going in 5th year after year. Japan’s entire $5 trillion economy has gone addicted. Government officials, business executives, households and investors took it for granted that the BOJ would leave the yen printing presses on “high” indefinitely.

There was indeed a brief moment around 2006 when the BOJ tried to wean the nation off the monetary sauce. He even managed to achieve a few slight rate hikes.

It did not work. The public outcry has been fierce and the economic fallout on business confidence and investment momentum has been even worse. In 2008, the BOJ reduced borrowing costs to zero. Then QE again. In a sense, the financial empire fought back. Requests for additional monetary blows were answered by an enabling central bank. And that’s a shame.

Two decades of excessive monetary welfare, essentially, ended up stifling the very animal spirits that Japanese policymakers had tried to rekindle. The incentives for government officials and corporate CEOs to disrupt, restructure, innovate or take risks are gone.

Why implement unpopular or risky new strategies when it is easier to exploit the BOJ’s liquidity giveaways? The irony is that in 2012, when then-Prime Minister Shinzo Abe took power on a pledge to reform the economy, he too fell back on the BOJ printing presses. .

Abe hired Haruhiko Kuroda to find a higher stimulus mechanism and end deflation once and for all. Governor Kuroda has stepped on the throttle more aggressively than ever, relieving Japan Inc. of any responsibility for reviving its innovative spirit or increasing its productivity. Rather than upping its economic game over the past nine years, Japan has increased the dosage of steroids. This basically lost the future for China.

Enter Powell, the least confrontational Fed chief in decades. He bowed to former President Donald Trump and cut rates to zero. Then in 2021, under President Joe Biden, Powell refused to outpace the inflation curve with one or two rate hikes.

Back in, say, September 2021, it was possible that the surge in inflation was transitory, tied to supply chain turmoil passing. But central banking is a game of trust. All it takes to guide investor perceptions are small but deliberate steps to curb speculation. Now it may be too late as Russia’s war in Ukraine turns price increases into a five-alarm crisis.

Chances are the Fed will raise rates again soon. After that, however, expect long periods of ‘watch and wait’ as Powell’s team tries to portray rising inflation as the best of two scenarios, the other being a deep recession caused by aggressive monetary tightening.

No Fed leader wants to be blamed for a slowdown. And given the fallout from Covid-19, inflation, supply chain issues, geopolitical tensions, irrationally high stock valuations and a surging dollar, the stakes are ever higher. The costs of a policy error are higher than they have ever been. He could easily send US stocks down even more vigorously.

To be sure, economists are right when they argue that current inflation is less about easy money and more about mismatches between supply and demand and massive fiscal largesse. A dearth of technological investment to increase the productivity needed in the United States does little to help. But much of central banking is psychological. Right now, there’s little confidence that Powell knows what his job requires. More importantly, there is little confidence that he will have the courage to make unpopular decisions.

Japan reminds us that it is infinitely easier to cut rates to record lows than to restore normalcy. This, in a nutshell, explains why talk of a Fed Powell-like 1994 tightening cycle is greatly exaggerated.

Comments are closed.