Notes on the Revolution XIV/Yen Woes Jude Wanniski & David Gitlitz May 31, 1995

NOTES ON THE REVOLUTION XIV

BOSNIA AND JAPAN: These two front-burner issues on the planet’s plate are the direct result of President Clinton wishing to prove his resolute relevance as commander-in-chief. The Washington foreign-policy establishment is horrified at this new, dangerous level of Clinton’s incompetence. On the MacNeil-Lehrer News Hour last night, four of the nation’s most prominent Bosnia experts sat dumfounded with the absence of options left in the wake of the President’s decision to bomb. In a separate appearance on CNBC, Sam Donaldson said he is not a very good chess player, but he at least knows you do not make a move on the board unless you have considered what your opponent might do, so you know what your own next move might be. Not in Bosnia. The White House decision to take Japan to the brink of a trade war is also in the class of an international Waco in the making. Waco, after all, was the terrible result of Attorney General Janet Reno’s determination to show that the first woman to hold that office could make macho decisions. If all the smart guys in our Political Establishment are cringing as they observe Bosnia and Japan heating to an incendiary stage, why is nobody trying to get Bill and Hillary to reverse course? Alas, Senate Majority Leader Bob Dole, the Republican front runner, is himself a Bosnia bomber and a Japan basher. 

FRANCE: Conservatives who celebrated the election last week of Jacques Chirac as the new president of France are properly stunned. What was supposed to be a Parisian Jack Kemp is instead a corporate socialist, bent on adding to the nation’s economic miseries and 12% unemployment rate. He will increase the VAT to 20% from 18% to subsidize additions to the corporate workforce. The minimum wage, now $1200 per month, will be boosted by 5%. There are no changes in the rule that redundant employees cannot be laid off without a note from Nanny. 

CANADA AND MEXICO: Promising political developments both north and south of our borders. In Canada, the moribund Progressive Conservative Party has come back to life in Ontario, with its provincial leader, tax-cutter Mike Harris, on the verge of unseating socialist Premier Robert Rae in next week’s elections. In Mexico, where President Ernesto Zedillo remains in a zombie-like trance as rumors of national insolvency swirl around him, a Mexican Reaganaut has emerged victorious in Sunday’s gubernatorial race in Guanajuato, north of Mexico City. Vicente Fox, 52, who heads the state’s National Action Party (PAN), won a rousing 2-to-1 victory over the PRI ruling party’s candidate. From the little we have seen of Fox, we are impressed with his grasp of the mechanics of democratic, entrepreneurial capitalism. He apparently toys with the idea of merging the two opposition parties, his right-of-center PAN and the left-of-center PRD, glueing them together a la Reagan’s merger of blue-collar Democrats and supply-side Republicans. Fox has to wait until 2000 to challenge Zedillo for the presidency, but he could get to work immediately on snapping the president out of his trance. Luis Mercado, the estimable editor of El Economista, is frantically warning against Zedillo’s drift to an “industrial policy,” which is about all the International Monetary Fund will permit these days. 

FORBES: Steve Forbes tells me he will issue a statement tomorrow indicating his serious intent to seek the GOP presidential nomination. He says he’s been entertaining the idea since several of us suggested it in late March and that he is now prepared “to engage the idea,” with the intent of being “wedded to it” sometime in September. What will he learn between now and September? He likens it to a wedding engagement, saying that if he is as comfortable with the idea then as he is now, he will go ahead. The Wall Street Journal’s political columnist, Gerald Seib, this morning asserts that Forbes may get into the race if Newt Gingrich decides not to. Seib is correct in observing that the vacuum in the GOP field that opened when Jack Kemp dropped out would be filled by Gingrich or Forbes. He’s incorrect in suggesting that Forbes awaits Newt’s decision. My guess is that Newt will remain where he is as long as he sees Forbes genuinely filling the void. If Forbes’ political inexperience proves a greater liability than expected, we would assume Newt would be pulled into the vacuum.

Jude Wanniski

YEN WOES

Today’s coordinated central bank intervention has momentarily lifted the dollar’s foreign exchange value -- approaching 85 yen at mid-day -- but its effect will undoubtedly prove to be fleeting unless the Bank of Japan begins pumping fresh liquidity into the Japanese financial system once again. 

As we observed earlier this month, the BoJ had actually reversed a fair portion of its deflationary liquidity drain that pushed the dollar to its April lows of around 80 yen. Between mid-month and last Thursday, May 25, the central bank had injected more than 2 trillion yen. As a result, the dollar had firmed and stabilized at about 87. This is where things were heading into Tokyo trading last Thursday when the BoJ signaled to the markets that Friday’s open market operations would return to a drain mode -- to the tune of more than 1 trillion yen. In Japanese trading Thursday, the dollar lost a full yen, to 86.25, and proceeded to pound below 85 in New York. When Friday dawned in Tokyo, the bank’s yen withdrawal was even worse than expected. At more than 1.8 trillion yen, the BoJ in one fell swoop wiped out nearly all the positive effect of its operations during the previous two weeks. In the three days since, the drain has continued. The net injection of more than 2 trillion yen between May 15 and May 25 has turned into a net withdrawal of 660 billion. Thus, the dollar has struggled to stay on the positive side of 83 yen. 

In Monday’s edition of the Asian Wall Street Journal, Kengo Inoue, a senior BoJ official, published a lengthy response to my April 21 Journal op-ed, “Where the Bank of Japan Errs.” Inoue is particularly critical of my insistence on looking at the yen gold price (down more than 27% from a year ago), which he derides as a “sort of philosopher’s stone” rather than a reliable monetary reference point. As opposed to being deflationary, he says, Japanese monetary policy has actually been quite stimulative; witness the drop in interest rates. In attempting to refute my analysis, however, Inoue ends up conceding a large point when he writes: “In the short run, the Bank of Japan can supply reserves only to the extent they are demanded. Reserves do not earn interest, and banks do not want to hold excess reserves when they do not expect loan demand to rise.” My article makes the same point in explaining why deflation expectations actually cause unwanted reserves to appear on the market, which the BoJ must then mop up, even as interest rates drop. Inoue apparently agrees, although he suggests that central bankers attempting to reverse the situation encounter the dilemma of “pushing on a string” -- i.e., the difficulty of encouraging lending when there is insufficient demand for funds. Inoue’s reasoning is circular, however. Loan demand will not rise until borrowers can expect to earn a real return on the funds -- in other words, until they are confident of deflation’s demise.

One hopeful sign is a growing awareness among Japanese market participants of the BoJ’s error in continuing to drain liquidity. Although market rates have fallen this week in the wake of weak economic data, an AP-Dow Jones dispatch from Tokyo today says, “the Bank of Japan’s money market operations in the past few sessions have been widely regarded as tighter than expected.” The service quotes an anonymous BoJ official as saying he would “accept the market’s interpretation that the Bank of Japan’s operations were tighter than the market’s expectations.” In Japan’s consensus-oriented policymaking system, such seemingly innocuous remarks could represent an early sign of policy change.

David Gitlitz