Too Early For Japan To Advise China On Defeating Deflation

Angrick adds that the“headwinds facing the economy are substantial. Exports are struggling and are unlikely to improve much before year's end. Household finances are stretched. Monthly cash earnings saw a big jump this summer, but this was driven largely by stronger bonus payments, so we look for more evidence that wage growth will stick.”

Despite the mixed data, Angrick concludes,“the Bank of Japan seems determined to tighten monetary policy. At best, further rate hikes will be an added drag on growth. At worst, they could precipitate a broader downturn.”

Which is exactly what worries Suzuki and his Liberal Democratic Party. The question now is whether Japan is about to see a replay of the 2006-2008 period, the last time the BOJ tried to normalize rates – only to abruptly reverse course.

Back then, the Toshihiko
Fukui-led BOJ managed to end quantitative easing and engineer two 25-basis-point tightening moves, getting short-term rates as high as 0.50%.

As economic growth slowed, the political backlash was fast and furious. By 2008, Fukui's successor, Masaaki Shirakawa, was beginning the process of restoring QE and cutting rates back to zero. So might Japan see a repeat of this policy-reversal dynamic in 2024?

For now, Ueda is arguing it's full speed ahead on rate hikes. It's not clear, though, that upcoming economic data will support that view. Particularly at a moment when Suzuki's team at the Ministry of Finance appears to believe things could go either way with deflation.

One question is the structural place at which Japan finds itself. A fast-aging population like Japan's is inherently deflationary. Folks in their 70s don't tend to consume like those in their 20s and 30s on new homes, cars, appliances, education, travel and entertainment.

Another: the“deflationary mindset” that continues to confound Tokyo. For a couple of generations now, Japanese households didn't just grow used to stable-to-lower prices. They came to depend on the trend. In high-tax, stagnant-wage
Japan, sliding costs acted
like a stealth tax cut of sorts. It actually increased household spending power.

In China's case, weak prices could reap some benefits for corporate profits.

The problem now is that Japan is finally experiencing inflation, but households aren't happy about it. Consumer prices are rising faster than average wages, causing something of a socioeconomic culture shock.

In the decade that Kuroda ran the BOJ, his team aimed to launch a virtuous cycle of wage gains that boosted corporate profits and earned workers bigger and bigger paydays. The opposite is happening. Most of Japan's inflation is being imported thanks to elevated commodity prices and a weak yen.

This, in turn, is undermining consumer spending.“Elevated inflation continues to pose challenges to Japan's retail sector,” write analysts at Fitch Solutions unit BMI.

As China wages its own deflation battle, it would be helpful to have a blueprint to which to refer. Tokyo, of course, should be that case study. Yet 25 years after first cutting rates to zero, it's not clear that even Japan has learned the lessons from its own lost decades.

No one understands this better than Kuroda. Better than any current central banker, he knows that inflation isn't always a monetary phenomenon, no matter what Nobel laureate Milton Friedman and his ilk argued.

Without bold structural reforms that alter incentives, increase competitiveness and level playing fields, monetary easing alone won't reverse a major economy's falling-price troubles. And at the moment, China's latest“inflation data confirms deflationary pressures remain entrenched,” says Carlos
Casanova, economist at Union Bancaire Privée.

Worse, he says, data on producer prices“was more negative than anticipated, reflecting concerns about overcapacity in key sectors, which has led to discounted factory prices.” Casanova notes that“upstream pressures continue to impact the overall pricing landscape,” he adds.

To stabilize prices, Pan's team at PBOC could slash rates further. In July, for example, the PBOC surprised markets with a cut in interest on 7-day reverse purchase agreements to 1.7% from 1.8%. At the time, the PBOC said the aim was to“step up financial support for the real economy.”

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Yet the move also reflected what Morgan Stanley economist Robin Xing calls the“reactive nature of easing.” Bruce Pang, chief economist at Jones Lang Lasalle, adds that downward pressure on mainland prices reflects the drag from a weak real estate sector.

The PBOC is reluctant to cut rates again for fear that a falling yuan might fuel other problems. This tension has Pan's institution crossing swords with bond traders pushing rates downward faster than the PBOC desires.

Goldman Sachs strategist Xinquan Chen says this has the PBOC preoccupied with“Chinese-style yield curve control.” As Chen puts it,“the efforts to set a floor for long-term Chinese government bond yields appear to be effective for now, but weak domestic demand and poor sentiment may drive yields lower in the medium term.”

President Xi Jinping's government also could be doing more.
“The fiscal policy stance needs to become more proactive in order to prevent the deflationary expectations from becoming entrenched, in my view,” says economist Zhiwei Zhang, president of Pinpoint Asset Management.

As Japan has taught the world, though, a multi-pronged burst of monetary stimulus, fiscal pump-priming and supply-side upgrades are needed to stabilize prices.

Japan has had a quarter century of the first two levers but too little of the third. The glacial pace of moves to modernize labor markets, cut red tape, catalyze a startup boom and empower women has Japan firing on fewer cylinders than it should be in 2024.

All of which makes Kuroda's holding court in Shanghai, pretending that these challenges are in Tokyo's rear-view mirror, a bit amusing. Granted, Kuroda did so respectfully. But current and former BOJ members might want to aim their criticisms and advice Tokyo's way, first.

Follow William Pesek on X at @WilliamPesek

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