A new yen for assertion

Japan's recent emergence from a negative interest rate regime marks a new assertiveness on the part of the first post-World War 2 miracle economy

A new yen for assertion

Puffer-fish toxin will kill you, if you do not first remove the skin, liver and ovaries of the fish with deft, delicate strokes of the knife to prevent the poison from leaching into the fish’ delicate flesh. With the Japanese, such subtlety is not confined to matters culinary. Therefore, it would be wise to see in the Bank of Japan’s first increase in policy rates in 17 years, on March 17, a little more than a tweaking of the rate by 0.1 percentage point. Japan has finally witnessed two successive years of 2% plus rise in prices, and is about to enter a new era of geopolitical assertion.

A visibly weakening yen, notwithstanding the end of Japan’s yield curve control strategy, might seem to mock such a contention. But also consider the implicit upgradation of Japan’s status in the United States’s scheme of things at the recent US-Japan summit in Washington DC. Japan is now America’s global partner for a free and open, rules-based world order, not just partner for a free and open Indo-Pacific. That marks a subtle (what else?) shift in the balance of power among the Quad members, India, Australia, Japan and the US.

Paul Volcker is remembered as America’s inflation killer, who, backed by Presidents Jimmy Carter and Ronald Reagan, raised interest rates to 20%, in order to tame inflation in the US, even at the cost of inducing a recession. That rise in interest rates also strengthened the dollar against other currencies. Europe, especially Germany, and Japan ran up big current account surpluses vis-à-vis the US. Now, a strong currency encourages imports; and cheap imports help keep prices down. But imports displace domestic output, to a certain extent (even as imported components could boost output, too). That produces anxiety about domestic jobs and the health of the domestic industry.

The never-ending flood of Japanese imports gave Godzilla a menace that went beyond the literal terror exuded by a monster from the deep. Reagan’s treasury secretary James Baker strong-armed Japan, Germany, Britain and France into strengthening their currencies vis-à-vis the dollar, in a bid to stem the rise in US current account deficits. This was the Plaza Accord of 1985.

This was the peak of the Cold War, with Tokyo seeing in America its only shield against the Soviet Red Army. Japan agreed to the rapid climb of the yen from 250 to the dollar to 130 to the dollar, despite the harm such a steep, artificial strengthening of the currency could wreak.

The preternaturally strong yen made every traded good suddenly cheap in Japan. Falling prices mean deflation – the value of goods and services crash. In order to boost economic growth, Japan went in for both a fiscal stimulus and interest rate cuts. Since prices stayed depressed, the Bank of Japan could cut rates a whole lot. Ultra-cheap credit set off a boom in asset prices. Stock markets boomed, real estate soared. Japanese multinationals borrowed cheap, and armed with oodles of strong yen, acquired companies and real estate around the world. Godzilla redux.

The Japanese central bank raised rates, to curb asset price bubbles. Real estate crashed, the Nikkei index halved. Japan entered the stage of its demographic transition when the population begins to decline. Thus began Japan’s lost decades. Attempts at recovery were jammed by first the Asian Crisis, the Mexican and Russian debt crises, the rise of China as an export powerhouse, and, finally, the Global Financial Crisis of 2007-09. The Fukushima nuclear disaster of 2011 did not help matters.

Japan’s rate of inflation dipped below 2% in 1992 and showed its head above that water level just once, in 2014, till 2022. Shinzo Abe as prime minister in 2012 launched a policy to reflate the economy, with expansionary fiscal policy, printing of money to create ultra cheap interest rates and some structural reform. In 2016, at a time of growth despair around the developed world, Japan adopted negative rates, in the hope of boosting growth. According to World Bank data, in constant 2015 dollars, the growth rate of the Japanese economy in the 22 years to 2022 compounded to an annual average of less than 0.6%.

That ill suits the first Asian economy to industrialise, the first Asian power to have a naval victory over a European power, the country that could send its navy across the Pacific to attack an American naval base in 1942, the first miracle economy sustaining a growth rate in excess of 10% for a decade, the innovator of the Walkman, productivity councils, just-in-time production, electronic games that took over the world, manga and anime.

With American politics inclined towards populist isolationism, as indicated by nearly half of American voters plumping for Donald Trump, and the rise of China, Tokyo can no longer afford to rely just on America for its own protection. Leave aside agreeing to another version of the Plaza Accord, Japan is likely to see moves towards greater self-reliance in defence production and defence strategies, even as it  tries and preserves as much as possible from its alliance with the US.

A rising India is the world’ instrumentality to keep China’s rise peaceful. India can gain from Japan’s new yen for self-assertion, of which release from a negative interest rate regime is but the first, if subtle, step.