of economic growth, low inflation, and an endless trickling down of material goodies to the great unwashed. Unfortunately, all great things must come to an end: Greenspan had perforce to retire after so many years of Herculean labor.
The Great Man has been succeeded by Bernanke as Keeper of the Flame and Guardian of the secret mysteries of high finance. Unfortunately, in his first confrontation with trouble, Bernanke has allowed the sacerdotal raiment to slip a tad, demonstrating weakness, uncertainty, and ineptitude. Still, the central bank, and the Chairman as well, remain revered figures in the secular Pantheon. (At least so long as no serious recession or major political difficulties eventuate under the newly-anointed Chairman's stewardship).
America, a technocratic, statistically-oriented, yet hero-seeking society has a profound psychological need for a high priesthood of money, in view of the disdain in which the political class is deservedly held.
In Japan, things are quite different. Indeed, the Japanese experience may be indicative of where our own central bank is headed, both substantively and symbolically.
Japan's contemporary economic history is dominated by two catastrophic "policy errors," each made by the Bank of Japan (BoJ). The first was the 1980s error of excessive money creation and a deliberately contrived ultra-low interest rate regime. In all fairness, we must note that this was not only the decision of the BoJ. Rather, it was the entire government and the long-ruling Liberal-Democratic Party which made the policy decision. The Japanese establishment was motivated by the perceived need to satisfy the United States. The Reagan Administration wanted lower American interest rates without causing a true collapse of the dollar and the attendant evils of panic and runaway inflation. Japan, the most powerful economy and financial powerhouse in the world after the U.S., was therefore prevailed upon to keep its own interest rates low and to prevent the yen from skyrocketing against the dollar.
The policy worked fine for us, but turned out badly for the Japanese. The flood of yen catalyzed an unprecedented real estate and stock mania, facilitated by imprudent lending by the major Japanese banks. (sound familiar?) The bubble -- one of the greatest in history -- did not collapse of itself. It was the BoJ, under the stewardship of Governor Sumita's successor, Yasushi Mieno, which deliberately punctured the bubble by raising interest rates and keeping them elevated until the inevitable occurred.
This second great policy error produced a nearly 20-year depression/deflation, which has still not ended. The great Japanese economy was severely hobbled by Japan's own central bank.
Throughout most of this period, the BoJ was unable/unwilling to bring the deflation/depression to an end. The central government engaged in astronomical deficit spending, in accordance with the Keynesian formula, to prevent the situation from degenerating into an uncontrollable downward spiral culminating in massive unemployment. These efforts, though roundly criticized, achieved sufficient success for Japan to avoid a classic economic collapse.
Finally, the BoJ, under the soon-to-retire Governor, Fukui, adopted a very aggressive accommodationist monetary policy several years ago. For the first time, the BoJ aggressively sought to force-feed money to the banking system and, with the government's cooperation, to relieve the banking system of its gargantuan bad loans. Fukui's policy of "quantitative easing" seemed to work. The Japanese economy began to recover. The stock market rallied substantially, nearly doubling from its trough. Even real estate prices -- at least in the desirable sections of Tokyo -- began to rise after nearly 20 years of decline. A sustained recovery was beginning!
And then what happened? Well folks, believe it or not, BoJ Governor Fukui decided that it was time -- you guessed it -- to start RAISING INTEREST RATES and TIGHTENING MONETARY POLICY. Fukui informed everyone -- the Cabinet, the Diet, the media -- that it was necessary to start "normalizing" interest rates. Japan had to prevent the emergence of -- you guessed it -- INFLATION! This, despite the fact that a 15-year DEFLATION in real estate prices, and a 10-year overall price DEFLATION had not yet ended! Yep, the BoJ was looking ahead!
The BoJ fought tooth and nail to implement its new policy. The prime minister objected repeatedly, warning publicly that the deflation was not over, that it was premature to raise interest rates and tighten policy. The Finance Minister reiterated these warnings. The Liberal Democratic leadership demanded that Fukui not implement his new plan. LDP leaders in the Diet threatened to pass legislation depriving the central bank of its authority to set short-term rates and determine monetary policy.
It was all to no avail. Fukui plowed ahead. The economy, the BoJ stated, was strong enough. The deflation had ended, or soon would. "Normalization" had to begin -- now!
The BoJ managed 2 interest rate hikes. The economy stalled, then started contracting. Prices -- which seemed to have stabilized momentarily -- resumed their decline. This is where Japan is today.
The obsessive fixation of the BoJ on an imaginary "inflation" even in the face of an actual and continuing deflation attests to the compelling power of this psychosis among central bankers. When a central bank is allowed to implement its wishes the results are what we have witnessed in Japan for the past 15 years.
Our own Federal Reserve of course is afflicted with the same inflation fixation. It is consequently imperative that intense pressure from politicians and lawmakers be exerted -- or legislated if necessary -- if we are to avoid Japan's sorry fate.
The problem with central bankers is that they do not know when to stop.
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