In memory of Dr. Andreas Höfert

The Japanese tradition of monetary experiments

The announcement by the Bank of Japan (BoJ) of its plan to double the monetary base and double its holdings of Japanese government bonds within the next two years to achieve a 2% inflation target has split economists. Some hail this policy, which has been dubbed 2222, as the long-awaited relief from the double decade of deflationary stagnation.

Japan is finally doing what US Federal Reserve Chairman Ben Bernanke recommended in his (in)famous 2002 “helicopter money” speech (“Deflation: Making sure it doesn’t happen here”). Others have deemed it the “Japanese end game,” which will fatally lead to uncontrolled inflation and Japan’s bankruptcy.

However, the vast majority of commentaries is pointing out the uniqueness of such a policy. But as spectacular as it might seem, the Japanese monetary policy is not unique when considered in the current context of other central banks from industrialized countries. Many of them have doubled, tripled, even quadrupled their balance sheets since the financial crisis began five years ago. Nor is it unique if one takes the time to look at Japanese history, in which monetary experiments have a long tradition.

Korekiyo Takahashi was a major Japanese politician in the first decades of the 20th century. The biography of this larger-than-life figure is the stuff of novels.

Born in Edo (old Tokyo) in 1854 into rather modest circumstances, he left Japan at 14 to learn English in California. There, under rather bizarre circumstances, he became a menial laborer but ultimately succeeded in escaping. Upon returning to Japan he taught English conversation before becoming a school director and then the director of the newly founded Japanese patent office. In his mid-30s he left the country again to manage a silver mine in Peru. In 1892 he started to work at the Bank of Japan, where he rapidly climbed the career ladder to be nominated as its governor in 1911.

Starting in 1913 Takahashi became a regular member of the Japanese government, first as Minister for Education, then as Minister for Agriculture and in 1921 as Prime Minister. However, it was as Finance Minister in no less than 17 governments that he had his biggest impact.

Like every other industrial nation, Japan was hard hit by the Great Depression at the beginning of the 1930s. Takahashi was one the first central bankers to try something other than the usual “laissez faire” type of policy.

In 1931 Japan took the lead in leaving the then-prevailing gold standard. This move enabled Takahashi to launch large-scale public works infrastructure projects financed by the printing press, three years before Franklin Delano Roosevelt initiated the New Deal and five years before John Maynard Keynes published his General Theory of Employment, Interest and Money. Japan experienced a boom that had no equivalent among the other Depression-embattled countries.

However, there was no happy ending. The massive depreciation of the yen boosted Japan’s textile exports, which led the UK and the US to adopt protectionist measures. International trade crumbled during this early currency war.

And Takahashi’s policy was not only internationally destabilizing. Japan’s economy showed more and more signs of overheating and inflationary pressure. Takahashi understood the situation and embarked, in 1934, on a program to cut government spending, in particular military expenditures.

This decision proved fatal. Soldiers began rebelling. In 1936 young officers attempted a coup. Now 81, Takahashi was shot along with other renowned Japanese politicians. Though the coup failed, the prestige of the “loyal” army increased and led to an even deeper militarization of the Japanese society, which had disastrous consequences.

Of course Japan today is not comparable to the Japan of 80 years ago. Nonetheless, we can learn something from this early attempt at quantitative easing.

First, monetary policy can never be done in isolation. The new Japanese monetary policy has increased resentment among direct competitors of Japan, chiefly South Korea and China, in ways similar to what Takahashi’s measures did with the UK and US. Countermeasures and a flare-up of the currency war in the East have become likely.

Second, every economic action has consequences. Some of them are intended, but others are clearly not. Takahashi paid the ultimate price for his policy.

Today, every central banker will argue that, despite a doubling, tripling or quadrupling of the monetary base, everything is under control. But just think about Japan and what would happen if its interest rates followed the targeted inflation rate? Despite the current rock-bottom interest rates, the Japanese government is using roughly one-third of its tax revenues to service debt, quite a fearsome perspective. This is why, in my view, the mantra that “everything is under control” is little more than wishful thinking.