The Japanese yen has been in near freefall against the dollar since late September. The Bank of Japan had just announced an expansion of its monetary stimulus, and BoJ Deputy Governor Hirohide Yamaguchi gave a dovish speech defending the central bank's actions.
Also in late September, Shinzō Abe was elected as the leader of Japan's LDP party, which before December's general elections was the main opposition party in parliament.
It was becoming pretty clear to markets that Abe could become Japan's next prime minister, bringing a dovish fiscal and monetary policy stance to the post, and he was ultimately elected to that office on December 16, returning the LDP to power in Japan.
The reason for the yen's sharp decline as of late is simple: Abe ran on a bid to revive Japan's long-moribund economy, and he's even gone so far as to threaten to strip the Bank of Japan of its independence – a rather unprecedented move in modern central banking that has economists and commentators buzzing around the world – if the Bank refused to take a more aggressive easing stance by raising its inflation target to 2 percent.
But what if, for all the talk of unprecedented aggressive monetary policy coming down the pike, that's really all it is – just talk?
That's what Stony Brook finance professor Noah Smith argues in his latest piece.
Of course, the power of simple "talk" isn't unique to Japan's situation – arguably the central banking theme of 2012 has been the role of simply influencing the market's expectations as a way to ease without actually easing. However, in order for central banks to change the market's expectations about the future course of monetary policy, the threat of future interventions has to be credible.
Smith suggests, though, that while Abe has been successful so far in "talking down the yen," there may not be much more to his plan – and all of the talk about stripping the BoJ of its independence may just be a big bluff.
In fact, according to Smith, it's likely all just a cover for Abe to proceed with what he really cares about – pushing through legislation on social and foreign policy issues that will shift Japan far to the right of the political spectrum in many ways.
One particularly egregious and controversial example of this is Abe's attempts to revise an apology Japan issued in 1993 to women who were forced into sex slavery by the Japanese military during World War Two.
Speaking a day after the new cabinet was named, the official, Chief Cabinet Secretary Yoshihide Suga, who serves as the government’s top spokesman, refused to say clearly whether the new prime minister, Shinzo Abe, an outspoken nationalist, would uphold the 1993 apology.
Mr. Suga said at a news conference that it would be “desirable for experts and historians to study” the so-called Kono Statement, which acknowledged the Imperial Army’s involvement in forcing thousands of captured Asian and Dutch women to provide sex for Japanese soldiers. Most historians say the women were coerced and were not prostitutes, as Mr. Abe and other nationalists have claimed in the past.
That may sound a little wild – especially when such a gesture will likely stoke tensions with Japan's Chinese and Korean neighbors – but it highlights just how focused Abe is on his nationalist agenda.
This is central to Smith's argument that all of this talk about monetary easing was just a trick to get Abe re-elected once again, so he can focus on these social issues that he cares about most.
Smith writes in his piece:
Instead, what I mean is that Abe really just does not care very much at all about the economy. I mean, of course he wants Japan to be strong, and of course he doesn't want his party kicked out of power. But his overwhelming priority is erasing the legacy of World War 2, with the economy a distant, distant second.
This is why Abe allows himself to be surrounded by corrupt and incompetent people. He is entirely focused on his cultural conservative quest. The other day Abe called Obama "Bush" . He just deeply, truly, does not care about stuff that does not involve boosting Japanese nationalism.
This argument actually makes a lot of sense if you look at Abe's history. He is, in fact, a career politician. Abe graduated with a degree in political science in 1977, and by 1982, he had entered the political sphere, where he has remained since.
Yet 1982 doesn't even really mark Abe's first foray into the world of politics. Abe was born into something of a political dynasty in Japan. His grandfather served as prime minister, and his father and other grandfather were politicians as well. In other words, politics is all Abe has really ever known.
Smith continues to hammer on this idea that as a career politician, Abe is really just interested in political issues:
By making lots of noise about revoking the BOJ's independence, Abe is trying to convince foreigners that inflation is on the way, thus sending the yen south. Basically, he is taking a page out of the LDP's old playbook - weaken the currency, pump up exports. Sure, it's not a sustainable strategy, but Abe doesn't need it to be sustainable; he just needs it to give the economy a fillip for long enough to let him complete his precious revision of the Japanese constitution. After that, he couldn't care less about what happens to the economy. It's a cursory, stopgap measure. To Abe, Japan's pride as a nation is infinitely more important than the fatness of its people's wallets.
This perspective leads Smith to hypothesize that those hoping for Japan to take center stage as ground zero of the world's next big monetary policy experiment in 2013 will likely be disappointed in a big way.
So what does this mean for monetary policy? It means that Abe is targeting exchange rates, not inflation (or NGDP). He'll do what he has to do to tweak foreign expectations enough to keep the yen weak, but he won't actually follow through and revoke BOJ independence. And even if by some miracle he does revoke BOJ independence, he won't insist on a hard inflation target. A non-independent BOJ wouldn't be controlled by Shinzo Abe, it would be controlled by the Ministry of Finance, and those people are just as likely to fear the peril of hyperinflation.
Expect Abe to continue making noise at the BOJ, and expect to see some token BOJ response, i.e. a bit more quantitative easing. If the yen starts rising again, expect Abe to switch gears and start talking about (or actually carrying out) currency market intervention of the type carried out in 2004. Essentially, he will continue the current talk of radical monetary policy experimentation precisely as long as he thinks it's holding down the yen, and then abandon it for a different mercantilist stopgap. Do not expect any real action against the BOJ.
Smith's whole piece is well worth a read. Check it out here >
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