[A-List] Bank of Japan

["Sabri Oncu" <soncu@xxxxxxxxxxx>]

http://www.iht.com/articles/2006/03/08/business/bank.php

Bank of Japan facing a momentous decision  
By Martin Fackler The New York Times

THURSDAY, MARCH 9, 2006 

TOKYO Is Japan about to trigger a sell-off in global financial markets?
 
Economists dismiss such fears as alarmist. But concerns have been building
ahead of an expected vote Thursday by the policy board of the country's
central bank, the Bank of Japan. At issue could be one of the most momentous
decisions in global finance today: whether the bank should end its
unprecedented policy of super-easy money, which has kept Japan's short-term
interest rates near zero.
 
Since no major central bank has ever had such a loose policy, no one knows
for sure how to end it smoothly.
 
Economists say the Bank of Japan must tread carefully to avoid sending shock
waves through the country's recovering economy - and through world markets.
 
"These are uncharted waters for a central bank," said R. Glenn Hubbard, dean
of Columbia University Business School, who is a central banking expert.
"Exiting with minimal disruptions will be a difficult exercise."
 
The world will be watching the expected vote, because any tightening by the
bank could mean the end to one of the biggest financial free rides in modern
history. The current policy was adopted in 2001 as an emergency measure to
inflate prices and prop up the country's teetering banks. But it also had
the unintended side effect of turning the country into a huge pot of free
cash for the rest of the world.
 
That is because half a decade of near- zero interest rates has driven
Japanese investors, from retirees to mega-banks, to buy foreign stocks and
bonds in search of higher returns. Global markets have also gotten a lift
from the carry trade, in which investors borrowed cheaply in Japan to invest
elsewhere.
 
The fear now is that this flow could suddenly reverse if Japanese interest
rates started to rise. This could spell trouble for overseas financial
markets like those in New York and London because Japanese investors could
start selling stock and bond holdings to repatriate their money.
 
While most economists call these concerns overblown, they do admit that
there is a kernel of truth, because Japan is a huge buyer of foreign
securities. They also warn that the anxieties could end up becoming a
self-fulfilling prophecy if overly nervous investors start pre-emptively
pulling out of financial markets.
 
"There is a risk of people overreacting," said Richard Jerram, a Tokyo-
based economist for Macquarie Securities. "The five-year free ride comes to
an end, or at least that's the fear."
 
The focus of all this attention is the Bank of Japan's governing policy
board, whose nine members began a regularly scheduled two-day meeting in
Tokyo on Wednesday. They will decide whether to end the current policy,
called quantitative easing, which essentially stuffed Japanese banks with
cash to help them write off huge bad loans accumulated during the
economically stagnant 1990s.
 
The policy also kept short-term rates near zero in the hope of ending a
corrosive downward spiral in prices.
 
Concerns of an imminent tightening have already made their presence felt in
financial markets as long-term rates have jumped since mid-January.
 
One reason for all the anxiety about the behavior of Japanese investors is
the size of their holdings overseas. Japanese individuals and companies held
overseas assets worth ¥107.7 trillion, or $915 billion, at the end of 2004,
according to the Finance Ministry.
 
The pace of Japanese investment overseas has also been quickening in recent
years. According to Bank of Japan statistics, Japanese investors bought
about ¥9.9 trillion worth of foreign securities in the three months ended in
September, three times more than a year earlier.
 
A reversal of these huge flows of cash could have even broader ripple
effects in the global economy, some economists say. If money grows scarcer
in the United States, interest rates could rise there, too. Economists say
this could lead to the far-fetched but not entirely implausible scenario of
the Bank of Japan deflating the U.S. real estate market, as home buyers face
more expensive mortgages.
 
"It probably won't happen, but there's always the possibility of unexpected
consequences," said Atsushi Nakajima, chief economist at the research arm of
Tokyo-based Mizuho Financial Group.
 
The bank's decision could also have huge consequences for Japan's own $4.6
trillion economy, which is finally growing again.
 
This has fueled a rare and often boisterous political debate between bank
supporters, who caution against undermining its independence, and
detractors, who warn that tightening too soon could snuff out the recovery.
 
Prime Minister Junichiro Koizumi echoed those fears Monday when he cautioned
the bank against moving too quickly, in a rare instance of the leader of a
major economy appearing to intervene in central bank policy.
 
"I am wary whether deflation has been beaten," Koizumi told a parliamentary
committee, according to Reuters. If the bank errs, "it cannot go back
again."
 
The Bank of Japan fears that maintaining easy money for too long could cause
the reviving economy to overheat, possibly creating inflation or a stock
market bubble.
 
The Bank of Japan's governor, Toshihiko Fukui, has repeatedly said that he
would like to return policy to a more "normal" footing as soon as consumer
prices show sustained gains, a sign that deflation is over.
 
That now seems to be the case, after the government said last week that
consumer prices posted their third straight gain in January.
 
Adding to the weight of the evidence, the central bank reported Wednesday
that Japan's banks increased lending in February for the first time in more
than nine years.
 
The bank has said that it wants to muffle the impact of a policy change by
keeping rates near zero as it removes excess cash from the banking system.
 
Hubbard of Columbia University said the bank also needed to tell investors
clearly what it wants to do after shifting policy.
 
The question arises, for example, whether it might set a target inflation
rate.
 
"Minimal disruptions will depend on how effective the Bank of Japan is in
communication," Hubbard said.