There have been a broad number of economists and apologists for the current policy approach being undertaken in Japan. Now, I don’t entirely disagree with Abenomics. In fact, there are components of it that I think are helpful. But what I find particularly misguided is how the stock market is being targeted quite explicitly via the portfolio rebalancing effect. It’s a version of what the Fed is doing in the USA though the Fed doesn’t buy ETFs as the BOJ does. And as I’ve explained before, the power in central banking is not in the SAYING, but in the DOING. Japan’s officials have not only said that they want equity prices higher, but they’re buying them as well. This has given Japanese market participants a false sense of confidence.
And this is where some economists seem to get confused on the cause and effect. For instance, when trying to pinpoint the cause of last nights 7% collapse in the Nikkei Dr. Krugman highlights three potential causes:
“1. Fears about weak Japanese and Asian growth.
2. Fears about Japanese debt– the bond vigilantes have finally arrived.
3. Fears about the resolution of the Bank of Japan, its willingness to persist in very expansionary monetary policy for a long time.”
One of those might have been a trigger, but the cause of the decline is ultimately the result of the market imbalances that have grown over the course of the last 6 months. For instance, what caused the housing bust in 2006/7? Who knows? But the cause of the boom was quite obviously an irrational supply and demand for housing backed by debt accumulation/issuance that was unsustainable. The environment in the Nikkei is not all that different. And when a central bank commits to be “credibly irresponsible” it’s not unusual for market participants to take them at their word. And the commitment to support equity prices gives traders a false sense of confidence which can then lead to a sort of ponzi environment which leads to a huge boom.
By committing to be “credibly irresponsible” the central bank can actually contribute to the boom which then creates the imbalance that results in the bust. Last nights collapse in the Nikkei wasn’t caused by one of the three aforementioned fears. It was caused by the imbalance that the BOJ has been a direct contributor to. Now, hopefully, this isn’t the beginning of a much bigger slide, but if history is any guide then it’s likely that the rollercoaster ride will continue for years to come. Personally, I find this concept of committing to be irresponsible a highly irresponsible form of policy that ultimately leads to increasingly risky environments and exacerbated boom periods that lead to exacerbated busts.