The longer China’s economy stalls, the lonelier Zhou Xiaochuan, governor of the People’s Bank of China, is certain to get. There’s simply no playbook for a central banker facing so many competing challenges: deflation, excessive debt, chaotic global financial markets and vested interests resisting reform. Zhou seems to have little choice but to make things up as he goes along.
But if Zhou is interested in consulting a cautionary tale, he might consider the decisions made by policy makers in Japan in 1998, when that country was on the precipice of deflation and bore an eerie resemblance to China’s present situation. (Japan’s deflationary slide was triggered by a massive debt buildup, a greying population and rigid industrial policies; if that sounds familiar to China watchers, it should.)
Unfortunately, Zhou seems committed to repeating the mistakes made by Masaru Hayami, the former governor of the Bank of Japan.
On Monday, Zhou cut the PBOC’s one-year lending rate by 25 basis points to 5.1 percent, his third cut in six months. That excited China’s stock traders. But, as Hayami’s experience shows, incremental moves of this sort aren’t a long-term fix. If Zhou hopes to avoid deflation in China, he should pay particular attention to three of Hayami’s missteps.
First, Hayami should have been far more aggressive with monetary stimulus. Initially, his problem was sheer denial. Two months before he took the helm at the BOJ in 1998, his predecessor Yasuo Matsushita insisted that there was no reason to expect deflation in Japan; Hayami operated under the same delusion after taking office.
Hayami eventually acknowledged that deflation was an issue, but even then he wasn’t bold enough. Although Hayami is sometimes remembered as the father of quantitative easing, which he pioneered in 2001, his initial attempts at monetary stimulus were far too timid. Part of the reason current BOJ Governor Haruhiko Kuroda is still pumping liquidity into the Japanese economy today is that 14 years ago Hayami only lowered rates hesitantly and incrementally. (The US Federal Reserve, by contrast, is preparing an exit strategy from its more ambitious quantitative easing program after just six years.)
The second thing Hayami should have done — and Zhou should do now — is take toxic assets off bank and local-government balance sheets. For a decade, Tokyo underreported the magnitude of its bad-loan problem; as a result, corporate Japan only got serious about writing off bad debt beginning in the early 2000s. If the BOJ had loaded up on distressed assets during Hayami’s tenure, Japan’s financial sector might have healed long ago. Instead, Japan’s distressed debt festered, its falling price cycle accelerated and its banks refused to extend credit because they suffered from what Kuroda calls a “deflationary mindset.”
Hayami’s third failing was that he was too timid with his bully pulpit. He was right to insist that Japanese deflation was less about the supply of yen than growth-stifling regulations, monopolistic behavior and a dearth of policy imagination in government. But he enabled Tokyo’s political paralysis in ways Zhou would be wise to avoid. Hayami, for example, could have sought a series of quid pro quos: I’ll print more yen, he might have told the government, if you shake up the banking sector, reduce trade barriers, cut red tape and tweak taxes to encourage innovation.
China can steer clear of these costly mistakes. Zhou could cut rates faster and by bigger increments as China’s deflation risks deepen. The PBOC could start taking loans that are destined to default off the books of big banks and municipalities. And Zhou could leverage his international gravitas to prod President Xi Jinping‘s team to internationalize the country’s financial system and foster greater competition in the economy.
But until now Zhou has only initiated baby steps, just as Hayami did. And there’s no reason to expect the results this time will be any different.
William Pesek is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region.
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