Wanted: An anti-deflation man (or woman)
By Richard Hanson

"To be a successful Bank of Japan bureaucrat, you should be cautiously optimistic, reasonably unpopular and constructively ambiguous." - Retired central banker, circa 1992

TOKYO - "WARNING: Potential Central Bank Governor(s) Crossing." No, Prime Minister Junichiro Koizumi didn't put out a sign in Nagatacho, the heart of Japanese central government, when he started looking for a candidate to fill the post of governor of the Bank of Japan (BOJ) that comes vacant on March 19.

The job seekers would probably put up campaign posters along the Imperial moat if discretion weren't assumed to be a positive trait for a central-banker candidate. No matter, these days the media do all the campaigning for them, whether they like it or not.

Those jockeying for attention have included prominent former government officials, private businessmen, scholars and writers. His appointments to cabinet posts and other positions have revealed diversity, a penchant for colorful characters - men and women - as well as staid conservative types.

Koizumi has watched them parade by with stoicism. It is clear that the decision does weigh heavily on him, though it is not his decision alone. By law, the "governor and the deputy governors shall be appointed by the cabinet, subject to the consent of the House of Representatives and the House of Councilors". Of course, Koizumi gets to pick the cabinet.

Politics aside, what Koizumi is wrestling with is the first normal use of the revised 1998 Bank of Japan Law, which gives whoever becomes the next governor a large measure of independence to carry out the duties of a central bank (issuing money, for example). Prior to 1998, the Finance Ministry wielded enormous influence over the central bank, the legacy of having been created by finance minister Masayoshi Matsukata in 1882.

That is one reason that Koizumi has taken his time in selecting a new governor for a mandated a five-year term in office. In theory, the prestige of the Bank has risen. Reality, however, has landed BOJ in the worst economic dilemma in recent history.

Whoever is named governor will face an immediate daunting task. For the past three years, the central bank has resorted to drastic anti-deflation measures, with little effect. Prices of assets and goods continue to decline steadily, while BOJ has held interest rates at zero percent and pumped trillions of yen into the economy to stimulate growth. Japanese officials were slow to recognize the danger of deflation in the 1990s. They have begun to spread the word.

This Friday and Saturday, the financial chieftains of the Group of Seven (G7) major industrial nations are meeting in Paris in what amounts to a war council, with hostilities in Iraq set to commence any time. While the threat of war in Iraq overshadows all else, Japanese Finance Minister Masajuro Shiokawa, 80, and Bank of Japan governor Masaru Hayami, 77, are presenting their own dire warning of another clear and present danger, that of "global" deflation - the worldwide version of the localized phenomenon that has sapped Japan's economy since the 1990s.

Japanese officials now take the deflation threat seriously. They warn that the dangers of deflation already lurk in the price declines that are showing up in the economies of G7 states, with Germany's weak economy cited as a prime example. The danger, they warn, is that others will fail to heed the warnings, as Japan did to its regret.

In surprisingly stark language, the Finance Ministry is warning that "It will be too late once the situation [in other countries] resembles Japan's." For the past year, senior officials at Bank of Japan have been warning of the threat of deflation in some countries in Asia could become endemic.

For Koizumi, the threat of deflation has hit home and undermines the ambitious agenda of "structural" and other economic reforms that he set out when he became prime minister in April 2001. At the moment, the prime minister is battling to extend his own term in office, which could be measured in months if he does not secure the backing for another term as president of the ruling Liberal Democratic Party (LDP).

Politics is a rough business. First, he must square away the BOJ matter. Then he faces a swarm of local and prefectural elections starting in April.

As far as one can speculate, Koizumi has already made up his mind as to who is going to be put forth as governor. (On December 21, Asia Times Online said that since Koizumi "is determined to step up his fight against deflation, an emerging dark-horse candidate to become the next governor of the Bank of Japan ... could be Masaru Hayami, 77, currently the governor". See The hunt for the next BOJ governor, December 21, 2002.)

Starting this weekend he is reported to be testing the waters over the BOJ appointment in the Diet (parliament). First, he has to bring on board the leadership of his own party. That is tricky. He ran into bitter opposition within the LDP when pushing for reforms that will weaken the ability of the LDP to raise political funds from such vested interests as construction and road-building - cash cows for some powerful factions in the party who opposed Koizumi's election in the first place.

Speculating by the press over who will be the next governor is dicey business.

Take the case of the business daily Nihon Keizai Shimbun, which in December 1979 ran in its morning edition a full-blown headline "scoop" proclaiming Satoshi Sumita as the new BOJ chief. Three hours later, the prime minister announced Haruo Mayekawa was the real new governor. Nikkei knew they were the two finalists. It guessed wrong because it figured Sumita to win because he was senior to Mayekawa. Sumita had to cool his heels to get his turn.

Koizumi's penchant for secrecy is well known. In reshuffling his cabinet last September, he locked himself in and drew up the list on his own. Some cabinet members learned of their new assignments after the press releases.

What Koizumi needs is a central-bank governor with a clear-headed view of the economy, which so far has been a weak spot for an administration that will celebrate its second anniversary in April. A year ago, the prime minister confessed to one foreign journalist that he just couldn't fathom why the economy declined to grow despite all the money he was throwing at it. His lack of interest in economic matters left him vulnerable to bad advice, as economic conditions have continued to stagnate.

Japan has yet to address the economic consequences of a war in Iraq or continuing tensions closer to home, where relations with the neighboring rogue state of North Korea have turned dangerous after a major diplomatic breakthrough just last September. Koizumi stunned the world by becoming the first Japanese leader to travel to North Korea. Since then revelations about North Korea's nuclear-weapons and missile ambitions have brought a halt to most official exchanges.

And news on the economic front is not good, either.

The latest numbers on Japan's gross domestic product (GDP) show some growth in the fourth quarter (October-December) of 2002 - translating into a 2.0 percent annual growth rate. That is probably a mirage. The key indicator of price changes, called the GDP deflator, showed a 2.2 percent drop from the levels of a year ago.

If these numbers stand up after revisions, they point alarmingly to the biggest spike in deflation in two years despite the government and the Bank of Japan anti-deflation measures. This week, BOJ's own monthly monetary report chimed in with this chilly conclusion: "Economic activity remains flat amid substantial uncertainty about the outlook for the economy."

There also have been meager results from efforts to resolve other problems that hamper the economy. There has been stiff resistance from within the LDP to a more drastic approach to speeding up the disposal of bad loans made by the banking industry. That initiative was announced with great fanfare last October after Koizumi completed his first cabinet reshuffle. Politicians balked at the prospect of a further rash of bankruptcies, especially in badly hit local and regional centers as local elections loomed.

One former senior BOJ official summed up the economic dilemma: "With respect to the prospects of the economy for 2003, there are still divided views - optimists and pessimists - in spite of better-than-expected GDP data for [the] fourth quarter. Economic policies are now very much politicized."

The most brazen intrusion of politics into the arcane debate over deflation has come on the topic of setting some sort of "inflation targets" for the economy. The idea is to induce inflation through fiscal or monetary means - a concept the Bank of Japan instinctively sees as misguided (and a blatant intrusion into independence of the central bank). It is suggested that the central bank begin to buy up assets to raise prices to some agreed inflation target.

The chief proponent of the so-called Inflation Target school is an outspoken academic member of the Koizumi cabinet, Heizo Takenaka, who started off his career working for the government's now defunct Japan Development Bank. Under Takenaka, inflation targeting gained a fairly large following, though Koizumi kept his distance.

In last autumn's cabinet reshuffle, Takenaka was given enormous power over economic and financial policy. He was named to the dual post of state minister in charge of economic and fiscal policy as well as financial policy and financial institutions. His first attempt to crack down on the bad-loan problems at banks produced a sharp backlash. He underestimated the power of the bank lobby within the LDP.

More recently State Minister Takenaka put his foot in his mouth by seemingly promoting a form of stock-market investment in what are called exchange-traded funds (ETFs). He went so far as to suggest that his fellow cabinet ministers "would absolutely make money" under current stock-market conditions if they put their money into these ETFs.

Takenaka was not fired for these indiscretions, for which he apologized at a Diet Budget Committee meeting. Takenaka denied that he had tried to manipulate stock prices, a criminal matter if proven. A number of middle-ranked LDP lawmakers called for Takenaka's resignation from his cabinet posts. He is not an elected member of the Diet and therefore serves at the pleasure of the prime minister.

In any case, Takenaka is damaged goods and may not have much shelf life left if other indiscretions seeped to the surface. "Takenaka's future is not clear at all," said one observer. "It cannot be denied that he has almost totally lost his support among his cabinet colleagues as well as the LDP members."

This messy development is positive news for officials who believe inflation targeting is economic voodoo. Koizumi, to his credit, has steered clear in his meager comments on what sort of BOJ governor he favors. His remarks are limited to a person who would be a "deflation fighter" without reference to inflation targets.

That bodes well for BOJ candidates who have solid credentials and harbor no wacky ideas. The current favorite among active and retired BOJ people is former deputy governor Toshihiko Fukui. He might have been named governor instead of Hayami in 1998, but he left government service to take responsibility for a scandal that rocked BOJ during that period.

Or, the prime minister just might have found a candidate no one has fingered as a prospect. "Koizumi is so unpredictable that I cannot see what his next step will be," said the observer.

Being cautiously optimistic, reasonably unpopular and constructively ambiguous might just do the trick in these troubled times.

(©2003 Asia Times Online Co, Ltd. All rights reserved. Please contact content@atimes.com for information on our sales and syndication policies.)