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March
8, 2002, 8:00 a.m. |
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ould
it be that we're looking at the best chance of a Japanese turnaround since
the 1980s? Despite the country's history of false starts, the latest signs
are very promising.
Gold and commodity prices have risen sharply in recent weeks in yen terms, breaking above their 2-year and 5-year moving averages. If these key prices are sustained at current levels for several weeks, the change in the pricing environment, whether or not welcomed by the stubbornly deflationary Bank of Japan, will spread through the economy and be enough to break Japan's businesses and consumers out of their deflationary expectations.
Japan is also increasingly discussing tax-rate cuts, which is a decidedly welcome step. And over in the market, Japanese equities have rallied 18% since their bottom on February 6. (But a warning: this must remain an indecisive indicator as there were false 20% rallies in March 2001 and March 1999.)
Also, the U.S. economic recovery looks like it will be strong enough to change Japan's outlook. While strong U.S. growth in the 1990s wasn't enough to overcome the effects of Japan's deflationary monetary policy, it still improves the odds.
So, is this another false start or the real thing? To answer that, here are some tell-tale signs to look for in coming weeks:
Yen Stability. If Japan allows the yen to strengthen (and gold and commodity prices to fall), it would signal another false start on ending the deflation.
Higher Bond Yields. The yield on the 10-year Japanese Government Bond is now only 1.5% and hasn't started moving up. If Japan is actually going to stop its deflationary monetary policy and start growing, yields will move up substantially.
A Responsible BOJ? Not likely, but we can hope. For many years now, Japan's central bank has not taken responsibility for the country's deflation. And last week, the BOJ again stated that deflation is not a monetary phenomenon, reinforcing the deflationary expectations in the economy.
Size and Speed. The monetary base will need to start shrinking as the velocity of money — the rate that it turns over in the economy — goes up. The monetary base is now a whopping 15% of GDP, probably an all-time, all-nation record for liquidity hoarding. The turnaround key is for the Bank of Japan to use a price-rule monetary policy to smoothly take the excess yen out of the economy, keeping the value of the yen stable, as growth prospects improve.
If Japan is experiencing a true turnaround, it will have far-reaching implications for global growth, global equity allocations, and Japanese equities. But be watchful. We've seen these surges stall before.
— Mr.
Malpass is the Chief International Economist for Bear Stearns.