Japan goes for broke

One thing you can say for new Bank of Japan (BOJ) Governor Haruhiko Kuroda is that he's not timid. As the late President Lyndon Johnson was fond of saying, "sometimes you have to throw in your whole pot." That's what Kuroda has just done with the Bank of Japan's pot.

He and the bank are going for broke by buying as much government debt as necessary to create an inflation rate of 2 percent. The initial move will have the BOJ buying twice as much as the U.S. Federal Reserve has been buying in its quantitative easing campaign to get the U.S. unemployment rate down to 6.5 percent. But the BOJ has also promised to go far beyond even this uncharted territory if necessary to get to the targeted 2 percent inflation rate. The major question now is whether this will work or whether the country will just wind up broke.

Already the move has pushed the value of the yen against the dollar down from Y76/$ to Y96/$ for a devaluation of a little more than 25 percent over the past few weeks. As was the case when the Fed's quantitative easing (QE) measures led to a weakening of the dollar, the BOJ's QE induced yen devaluation has raised cries of alarm (as well as of satisfaction). For instance, the CEO of GM Korea has called on the Korean government to intervene in currency markets to buy dollars and yen in an effort to weaken the Korean won as a way of preserving the export competitiveness of Korea based auto production. Other Korean exporters have joined this chorus. Conversely, some Japanese auto executives have told me that it is now Korea's turn to suffer under a strong currency as Japan has been until recently.

Nor is this very concern very different from that of the Swiss who have tried to maintain export competitiveness by intervening in currency markets to prevent the Swiss franc from rising above prescribed levels against the Euro. Brazil and others have acted in similar ways in response to similar concerns.

At a moment when Japan is applying to enter the negotiations for a Trans Pacific Partnership Free Trade Agreement (TPP) and the United States and the EU are entering into negotiation of a Trans Atlantic Free Trade Agreement (TAFTA) and Japan is talking about a possible free trade agreement with the EU, these currency moves raise major trade issues. For instance, no one wants Japan to languish in continued deflation, but nor do the Koreans (and the Euro-American producers in Korea) want Japan to exit deflation at the expense of Korean exports and employment.

A major difficulty with all the free trade agreements is that their provisions do not deal with the impact of currency fluctuations. The original  General Agreement on Tariffs and Trade (GATT) was established under a fixed exchange rate international regime, and the WTO did not adjust trade provisions to a floating currency regime when it came into being. The result is that the removal of tariffs and other trade impediments can be overwhelmed in a matter of days or weeks by precipitous currency movements. Countries are then urged not to engage in "protectionist" policies in reaction. Switzerland, for instance, was condemned by many economic analysts and policy makers for its policy of defensive currency intervention which is a kind of protectionism. But what's a country to do? Industrial adjustment in real life is not as quick as in the econometric models.

It is completely unrealistic under prevailing currency circumstances to negotiate meaningful free trade agreements that might roughly conform to the rules of comparative advantage. Accordingly, the trade negotiators should expand their agendas to include some provisions for dealing with the impact of non trade related currency movements. For instance, countries like the United States and Japan that are engaging in massive QE might be expected to levy export taxes that would sterilize the trade impact of the QE. Or provisions might be established under which countries are authorized under specified conditions to impose temporary floating rate surcharges on imports from countries engaged in currency intervention and/or massive QE.

I know, I know. This raises the possibility of many dangers. Nevertheless, it seems that we should deal with the real world rather than persist in trying to impose the conditions necessary for the maintenance of a theory the assumptions of which have long been inoperative.       



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