December 2024 and January 2025 combined monthly

 

The Bank of Japan, which has become a hostage to the market, and the Ishiba administration, which is a rehash of Abenomics, may put an end to "boiled frog Japan"

 

Monday, January 6, 2025

 

Happy New Year. We sincerely wish you good health and happiness in the new year.

In this monthly, we will discuss the following topics in order: trends in international financial markets, inflation and monetary policy, fiscal policy, democracy, capitalism and the role of central banks.

The "wild" market at the end of 2024 and the contradiction between Japanese and US monetary policies

Now, while the dollar-yen exchange rate has shown momentum to approach the 160 yen mark since the beginning of the year toward the end of 2024, it is noteworthy that the Nikkei average stock price has once again attempted to break through the 40,000 yen mark, exceeding the highest value of the Heisei bubble (approximately 39,000 yen).

Behind these developments, shouldn't we see the actions of the Japanese and US central banks, which can only be seen as belonging to the "bubble cleanup faction"?

At the last US Federal Open Market Committee (FOMC) meeting of 2024, which the market was paying close attention to, the US Federal Reserve Board (FRB) decided to further cut interest rates by 0.25% (December 18). However, it has indicated its intention to slow the pace of interest rate cuts in 2025.

On the other hand, the Bank of Japan decided not to further raise interest rates at its final monetary policy meeting of last year on the following day, the 19th.

However, as will be described later, accelerating inflation is becoming clear in both the Japanese and US economies. In addition, there are no signs of a sudden economic slowdown in either economy. Rather, since the asset bubble has become even clearer in both Japanese and US financial markets, the risk of inflation being further pushed up by the expanding asset effect cannot be ignored.

Given such an accelerating inflationary economic environment, it is essential that the central banks of Japan and the United States, which aim for price stability and sustainable economic growth, aim for price stability first.

Is data dependent just a hollow promise for both the Japanese and US central banks?

By the way, the emergence of the Trump administration is not a first for us. The moves that the second Trump administration aims for, such as tariff hikes, tax cuts, illegal immigration removal, and deregulation, should be within the realm of expectation to some extent for both the Japanese and US central banks, even though it is impossible to foresee all of them.

In any case, as will be described later, Fed Powell's continuous interest rate cuts amid concerns about prices and even economic overheating in the US economy will greatly undermine the stability of the US economy, and it cannot be denied that there is a possibility that interest rates will be raised sooner rather than lowered.

On the other hand, given that it was already certain that the Ishiba administration would pass a large-scale supplementary budget for fiscal 2024 worth more than 2% of GDP, Ueda had no choice but to see that the negative impact of stimulating fiscal aggregate demand through a significant expansion of government spending on inflation in Japan was already obvious.

Therefore, given Japan's inflation of about 3%, the Bank of Japan has left the (nominal) policy interest rate level (+0.25%) to sink significantly to a real level of minus 2.75%.

If Ueda does not rush to raise interest rates, it is obvious that the already excessive monetary stimulus effect in Japan will be further amplified, and the vicious cycle between the further sharp fall of the Japanese yen and the resulting acceleration of inflation will become increasingly uncontrollable.

In any case, if they insist on ad hoc and arbitrary monetary policies, as if they are the exact opposite of a data-dependent or objective monetary policy rule-based stance, both the Japanese and US central banks will not be able to achieve the essential price stability and sustainable economic growth, and as a result, they may suffer a major backlash from the financial markets for the amplification of the asset bubble to date.

Incidentally, in the trading from Monday, December 30, 2024 to Tuesday, December 31, 2024, which corresponds to the first week of 2025, it appears that profit-taking is beginning to appear in the international financial markets in the new year in the ultra-bullish market that continued throughout the previous year. It is impossible to rule out the possibility that the development of the international financial markets in the new year will be the exact opposite of the ultra-bullish market of the previous year, and it is still unpredictable.

  

A review of the Bank of Japan's extraordinary monetary easing that does not teach us anything

 In fact, after the Bank of Japan's monetary policy meeting on December 19, in addition to the usual statement, a fairly important "multifaceted review" that reviewed monetary policy over the past 25 years was also published at the same time. Governor Ueda ordered its formulation when he first took office in April 2023.

Regarding the Bank of Japan's multifaceted review, a Nikkei editorial (dated December 28) makes the following persuasive summary:

However, any sensible citizen or investor should not lightly forget the significance of Black Monday, which suddenly occurred in midsummer on Monday, August 5, 2024, as the Bank of Japan did.

This is because the Nikkei average stock price fell 4,451 yen on that day compared to the closing price of the previous weekend, the largest drop ever, surpassing that of Black Monday.

In addition, the fear index (historical volatility = HV) of this August 5 Black Monday in Japan was 66.4%, and there is no doubt that it was the third most fearful event in the Japanese stock market. By the way, the only events that exceeded this fear level were the 115.1% of the "Lehman Shock" in the fall of 2008 and the 77.6% of the original "Black Monday" in 1987. The August 5 Black Monday in 2024 exceeded the 61.3% of HV during the collapse of the Heisei bubble.

The market crash of August 5 last year (Black Monday), which was a bolt from the blue that undoubtedly originated in Japan, was often covered in superficial and shallow reports at the time, and in the end, there seem to be many unfair experts who want to downplay its significance as much as possible and bury it in oblivion if possible. Unfortunately, it seems that Ueda BOJ is one of those representatives.

The author speculates that the original Black Monday in the United States in 1987 was mainly caused by the difference in the direction of monetary policy between the US and German central banks, and the Black Monday in Japan in 2024 was mainly caused by the difference in the direction of monetary policy between the Japanese and US central banks (see August 2024 Monthly for details).

If that is the case, given that Fed Powell plans to cut interest rates two more times in 2025, if Ueda BOJ moves to raise interest rates again in the future, it is possible that the August 5 Japan Black Monday that occurred in 2024 will not be reignited.

The Bank of Japan is already practically a hostage in the financial markets, and it appears unable to move. In any case, the Bank of Japan's "Comprehensive Review of Unprecedented Easing," which does not take into account the issue of international monetary policy coordination between Japan and the United States, is by no means persuasive.

Vicious cycle of prices and wages: Lessons from the oil crisis

By the way, on November 29th last year, Professor Emeritus Noguchi Yukio of Hitotsubashi University posted on Gendai Business Online a warning against the "vicious cycle of prices and wages" in light of the lessons learned from the oil crisis, rather than the "virtuous cycle of prices and wages" that the government and the Bank of Japan insist on. It is quite noteworthy that he has already expressed his objections to the Bank of Japan's "Comprehensive Review of Unprecedented Monetary Easing." Below, I will quote a part of the somewhat lengthy article in italics.

"Real wages are not rising because wage increases are passed on to consumer prices. The government and the Bank of Japan say that passing the increase on is desirable, but this means that small and medium-sized enterprises that cannot pass the increase on and people who are left out of the wage increase framework will be the victims. The government should stop the ongoing price rise. Prices rise because wages rise.

If we place importance on the position of people who are not eligible for wage increases, the current price rise is undesirable and it should be necessary to stop it. And this should be the basis of price control.

However, the government's price control measures acknowledge that prices will rise and then provide relief to those who are affected by them. It is not about suppressing price increases.

There are several problems with this policy. First, the target of the government's price control measures is not necessarily people who are not eligible for wage increases in the sense mentioned above. Gasoline subsidies are aimed at people with relatively high incomes. Therefore, many people are victims of price hikes but are not covered by the government's price control measures.

Secondly, the financial resources for the government's price control measures are ultimately borne by the people. Therefore, the people as a whole do not benefit from these measures.

Moreover, gasoline and electricity prices are only seemingly suppressed, and the causes are not addressed. Therefore, if price increases are caused by wage increases, the price increases will never stop, and therefore price control measures will never stop.

During the oil shock of the 1970s, labor unions in the UK and other countries were strong, demanding wage increases, and high wage increases were implemented. However, this further worsened inflation in the entire economy, and the economy fell into a crisis.

At that time, Japan was able to suppress wage increases and overcome the oil shock. This was because labor unions were based on companies, and the logic of corporate familyism that "excessive wage increases will cause the company to sink" worked.

The logic of corporate families is not always correct, but in this case, it can be said that it worked in the right direction to curb excessive wage increases. When considering the current situation, it is important to remember the lesson learned from this incident.

It is essential to combine the Bank of Japan's monetary policy with the government's fiscal policy.

However, it would be unfair to forget that the Bank of Japan's unprecedented monetary easing, which began in 2013, almost completely achieved its 2% inflation target in the first year.

With the start of Abenomics in 2013, the Japanese economy had escaped from the high yen recession, 2% inflation was almost achieved, and the economy had improved considerably by March 2014, at least, to a stage where sustainable economic growth was in sight.

However, this was greatly dampened by the permanent increase in the consumption tax rate to 8% in April 2014. This consumption tax increase was initiated by the Abe administration at the time, but the former Bank of Japan Governor Kuroda also actively supported the tax increase.

Since then, household disposable income has been reduced by 4.8% of GDP (60% (GDP ratio of personal consumption) x 8%) every year due to the permanent increase in the consumption tax rate to 8%.

Contrary to Kuroda's prediction, personal consumption naturally showed a serious decline after April 2014, and the Japanese economy has since fallen into a long-term slump again. As a result, Kuroda's Bank of Japan has expanded its extraordinary monetary easing measures, one after another, such as buying Japanese stocks, purchasing large amounts of long-term government bonds (QE), and negative policy interest rates, as if aiming for a last-ditch effort to revive the economy.

To make matters worse, without learning the lesson of the consumption tax increase to 8%, the Abe administration permanently raised the consumption tax rate again to 10% in October 2019, further aggravating Japan's long-term consumption stagnation.

Then, as a backlash against the radical fiscal and monetary easing policies implemented to overcome the COVID-19 pandemic that began in 2020, the inflation rate clearly began to exceed 2% from April 2022 onwards.

Despite this, during his long tenure of two terms over 10 years until March 2023, BOJ Governor Kuroda continued to adhere to the initial unprecedented monetary easing and even did not hesitate to amplify it.

Thus, the current BOJ Governor Ueda was appointed in April 2023 with high expectations, but unfortunately, even amid ever-increasing inflationary pressure, basic inflation has not reached 2% inflation, and he has continued to insist that it is desirable for a virtuous cycle of wage and price increases to be created in the Japanese economy, leaving the vicious cycle of currency depreciation and accelerating inflation, as well as the contradiction between inflation and long-term consumption stagnation, unchecked to this day.

In the end, the Bank of Japan has already failed greatly to recognize the accelerating inflation rate beyond the 2% price target that has been emerging since around April 2022 (see the figure on page 2). Now that it is 2025, about three years later, when the price level has already risen cumulatively by about 10%, it is clear that the Bank of Japan is no longer able to control the stability of our currency and prices.

Thus, the multifaceted review of the Bank of Japan's extraordinary monetary easing published in December 2024 is not only clearly off the mark, but also too late. In particular, the Japanese economy will not be revived by monetary policy alone, and the Bank of Japan's multifaceted review has become narrow-minded, mainly in terms of international cooperation and cooperation with fiscal policy.

Japan's accelerating inflation has already surpassed that of the United States

Now, as for the current inflation situation in Japan, it is no exaggeration to say that it is already on track to surpass that of the United States.

For example, Japan's producer price index (PPI) rose by +0.3% month-on-month and +3.7% year-on-year in November 2024, significantly exceeding the US PPI's +3.0% year-on-year increase.

Also, when looking at the consumer price index (CPI), Japan's core CPI (excluding fresh food) was +2.7% year-on-year in November, but the downward effect of the government's fiscal policy "emergency support to survive the heat wave" was -0.34%, and if this is added back, the actual inflation rate exceeds +3.0% year-on-year.

In addition, when looking at the instantaneous (seasonally adjusted) month-on-month inflation rate, Japan's core CPI inflation rate is +0.5% (equivalent to +6.0% on a simple annualized basis), which significantly exceeds the US core CPI's +0.3% month-on-month increase in November, and the acceleration of inflation in Japan is more noticeable at the moment than in the United States.

The "Reiwa rice riots" have become more noticeable since the summer of 2024. According to the latest December Tokyo 23 Wards CPI (released on December 27), rice prices rose sharply by +63.3% compared to the same month last year, and +0.7% compared to the previous month (simple annual rate of +8.4%), and there is no sign of the rice riots calming down.

In any case, there is no doubt that the credibility of the Bank of Japan and the government, who have decided to keep silent about the soaring price of rice, Japan's staple food, is greatly shaken from the consumer's perspective.

The ruling and opposition parties are handing out tax revenue increases while the media calls for fiscal reconstruction; there is no future for "Boiled Frog Japan"

By the way, the editorial of the Asahi Shimbun dated December 28th stated, "The ruling and opposition parties are conspicuous for emphasizing the 'return of tax revenue increases'. In discussions with the ruling party, the Democratic Party for the People called for income tax cuts and gasoline tax cuts, while the Japan Restoration Party called for free education. In order to gain approval for the budget bill, it is difficult to dispel the concern that the appropriateness of the budget will be neglected."

It is true that the expansion of fiscal expenditures should be restrained as much as possible. This is because it is difficult to expect sustained economic effects from a temporary expansion of expenditures whose effectiveness is doubtful.

In this regard, a permanent reduction in the consumption tax rate to 5% toward the abolition of the consumption tax appears at first glance to result in a tax revenue reduction of about 18 trillion yen, equivalent to 3% of GDP, due to a 5% reduction in the consumption tax rate on personal consumption, which is 60% of GDP.

However, in the vicious circle of a declining birthrate and long-term stagnation in consumption, a permanent reduction in the consumption tax rate to 5% toward the abolition of the consumption tax would actually increase household disposable income by the same amount, 18 trillion yen, and with the amplifying effect of the consumption multiplier effect, personal consumption and the economy as a whole would permanently recover significantly, and the fiscal balance could improve as tax revenues increase.

In addition, a permanent reduction in the consumption tax rate to 5% toward the abolition of the consumption tax would not only lower the inflation rate itself by 5%, especially in an inflationary environment, but it would also be very attractive to expect economic growth to increase by about 3% through increased consumption. It is self-evident that this would have a much greater economic effect than the income tax cut proposals prioritized by the Democratic Party for the People, which are like "picking around in a box with a toothpick."

In short, the key to solving Japan's current quadruple problems of low birthrate, long-term consumption stagnation, currency depreciation, and rampant inflation is a policy mix of large consumption tax cuts and interest rate hikes by the Bank of Japan, not prioritizing fiscal consolidation.

And it is clear that the first issue to be addressed when discussing the budget for the new fiscal year (2025) should be a permanent reduction in the consumption tax rate to 5% in order to abolish the consumption tax.

 

Is the November PCE disinflation rate good news for Fed Powell or a devil's whisper?

Looking at the US economy, we have pointed out from the beginning that there are signs of accelerating inflation and that economic growth is in danger of accelerating or even overheating. The main background to this is naturally the wealth effect on the economy resulting from rising stock prices and housing prices in the US.

For example, the US real GDP growth rate was +3.1% in the July-September quarter, exceeding the +3.0% growth rate in the April-June quarter, and is also expected to have recorded a high growth rate of +3.1% in the most recent October-December quarter (GDP Now, Atlanta Federal Reserve Bank, as of December 24).

On the other hand, the US inflation rate, not only increased by +0.4% month-on-month (+3.0% year-on-year) in the November PPI announced on December 12 on a comprehensive basis, but also increased by +0.3% month-on-month (+3.3% year-on-year) in November on a core basis excluding food and energy, which is downstream of the PPI, which was already announced on December 11.

There is no doubt that the US inflation rate has thus far exceeded the Fed's 2% inflation target.

However, one mystery has arisen about the accelerating trend of US inflation toward the end of 2024. The November PCE inflation rate, announced on Friday, December 20th after the release of the CPI and PPI, is the inflation index that the FRB considers most important as an inflation indicator, but it only increased by +0.1% from the previous month on both the overall and core bases, which was well below market expectations.

Since December 20th, the US financial market has been cheering on the slowdown in the November PCE inflation rate, which was lower than expected, and has turned into an almost one-sided bullish market until around Christmas last year.

However, it would not be wise to assume that the US inflation rate is falling and the trend toward de-inflation is becoming clear just based on the single-month decline in the November PCE inflation rate.

This is because PCE inflation is a price index measured based on actual consumer spending by individuals, but unlike the CPI, it reflects the substitution effect of price changes at any given time.

For example, in the face of accelerating inflation, ordinary consumers tend to save money under budget-constrained consumption behavior by substituting cheaper pork or chicken for beef, a typical luxury item that is only getting more expensive, or by refraining from buying expensive butter and increasing consumption of cheaper margarine.

For this reason, compared to the CPI, which reflects the items that individuals actually want to consume in the same way as before, the PCE may have a downward bias in the rate of price increase, especially during inflationary periods.

Thus, the November PCE inflation rate was significantly lower than market expectations and was a surprise to me, but it is not good news for Fed President Powell. In other words, it is highly likely that the November PCE statistics probably contained noise, or that the price substitution effect was temporarily strong due to the large increase in the CPI, which caused the PCE to temporarily fall.

In other words, if we ignore or underestimate the downward bias of PCE during such inflationary periods, we may mistake it for a signal for the Fed to lower interest rates, which could lead to a further acceleration of inflation, and there is a danger that it could become a devil's whisper.

The fact remains that American consumers and the general electorate are facing the threat of rising living costs due to high prices, not just the inflation rate.

In any case, there are concerns that the contradictions and disparities between the actual US economy and the country's financial markets, centered on stock prices, are widening at the moment, and it is Fed Powell who is amplifying these contradictions.

In addition, with the unorthodox US President Trump finally taking office on Monday, January 20, 2025, it is difficult to expect the uncertainty and risks surrounding US politics and the economy to decrease.

Democracy, capitalism, and the role of central banks to think about on New Year's Day

The editorial in the Tokyo Shimbun newspaper at the end of last year, titled "Thinking about democracy and the happiness of the people on New Year's Eve," was extremely persuasive, so I highly recommend you take a look. Below, I will briefly introduce a small part of it in italics.

"◆The rule of law promotes growth

This year's Nobel Prize in Economics was awarded to three people: Professors Daron Acemoglu and Simon Johnson of the Massachusetts Institute of Technology (MIT) and Professor James Robinson of the University of Chicago.

 

Through their research into European colonization, the three professors confirmed that democratic institutions are important for the prosperity of a nation, and that the growth of a society with a weak rule of law and a system that exploits its people will not last long.

 

Due to the rise of authoritarian countries, democracies are a minority in the world's population, so this award is encouraging for me as a resident of a democratic country, Japan.

 

The future of democracy in the United States led by Trump is a concern, but democracies such as Japan and the United States must reaffirm the importance of universal values ​​such as freedom, democracy, basic human rights, the rule of law, and market economy when confronting authoritarian countries....

 

The public's anger over the LDP's "politics and money" problem was reflected in the harsh results of the October House of Representatives election, when the ruling LDP and Komeito lost their majority.

 

The Upper House elections will be held in the summer of next year, and each party will strengthen its own claims to gain support, so the management of the Diet will remain difficult for a while, but the political situation of a minority ruling party is not all bad. ... This reminds me of the research results of the Nobel Prize in Economics mentioned above. "Growth in a society with a system that exploits the people and has a weak rule of law cannot last long." Changing the interpretation of the constitution and laws to suit the administration, as was the case during the Shinzo Abe administration, cannot be said to be a situation ruled by law. I would not go so far as to call it exploitation, but the LDP administration is trying to cover the financial resources for drastically strengthening defense capabilities under the pretext of a worsening international situation with an "arms expansion tax increase" that will impose a burden on the people. It is tempting to suspect that the low growth of the Japanese economy is also due to this authoritarian administration. The revival of democracy will lead to happy lives for the people. I would like to make next year the year in which the "buds" of revival grow and bear fruit. "

 

Incidentally, in its editorial on New Year's Day 2025, the Asahi Shimbun editorial, this time titled "In an era of increasing uncertainty, focusing on politics to build a strong society," featured a passage from "The Narrow Corridor to Prosperity" by American economist Daron Acemoglu, who won the Nobel Prize in Economic Sciences last year, just like the Tokyo editorial on New Year's Eve.

In it, Acemoglu sharply points out that "To realize a free and prosperous country, Acemoglu argues that it is necessary for the state, which is a power structure, and the society, which is made up of its citizens, to grow in balance."

The editorial goes on to say, "If left unchecked, the state will oppress its citizens. Society needs to monitor the state and put shackles on it. Moreover, the corridor in which the two can be in balance is very narrow."

In particular, in an interview with The Asahi Shimbun five years ago, Mr. Acemoglu stated that Japan's challenge was that "there is a lack of movement to encourage change at the ground level," and that "after 25 years of stagnation, it is surprising that no movement to rebel has arisen."

As Dr. Acemoglu already intuitively knew five years ago, it is undoubtedly true that, unfortunately, we, the ordinary people of "boiled frog Japan," have been plundered and exploited by a political and economic system that is hereditary, privileged, and vested interests.

For example, the double whammy of taxation, consisting of a 10% consumption tax rate and an inflation tax of about 3%, is a typical example. It is inevitable to see that the authoritarian Japanese government itself is becoming a shackle to the low economic growth of our country.

In any case, a government and central bank that does not achieve price stability and sustainable economic growth will undermine the economic growth, efficiency, and stability of society, and risk causing democracy and capitalism to fail.

Lenin is said to have once said, "The best way to destroy capitalism is to corrupt the currency" (Keynes, "The Economic Consequences of the Peace" (1919)).

Furthermore, far from generating innovation, high inflation is likely to fuel social unrest through speculation, inefficiency, and inequality in an asset bubble.

In short, wise citizens must bear in mind that achieving price stability and sustainable economic growth is an extremely important prerequisite for democracy and capitalism to develop and prosper without contradiction.

If things continue as they are, the Bank of Japan, held hostage by the market, and the Ishiba administration, which is a fourth-rate copy of Abenomics, could put an end to "boiled frog Japan."

Can we really draw up and implement a "scenario for Japan's revival" that is composed of an expansionary fiscal policy of a permanent reduction in the consumption tax rate to 5%, as well as a contractionary monetary policy that gradually raises the Bank of Japan's (nominal) policy interest rate over the course of about two years toward a real positive rate above the inflation rate?

The year 2025, which marks 80 years since the end of the war and 100 years since the Showa era, will surely be a major turning point that will determine the life or death of our country.

Finally, I would like to conclude by wishing all readers good health and happiness in the new year.

 

Tomo Nakamaru, former World Bank economist