China’s ‘Japanification’ Risk Haunts Tokyo, Too

With Chinese consumer prices trending negative, economists everywhere can’t help but view the phenomenon through the lens of Japan.

As mainland inflation recedes faster than gross domestic product, there’s a growing sense that the world has seen this movie before in a major Asian economy. Japan’s two decade-plus challenge with deflationary dynamics still stands as a cautionary tale.

It’s still arguably playing out. Sure, Japanese prices are spiking amid surging global energy and food prices. Thanks for that, Vladimir Putin! Yet on Friday, the Bank of Japan reminded the world that Tokyo remains too tethered to the 1999-2001 era for comfort.

In 1999, the BOJ became the first major monetary authority to slash official interest rates to zero. It was an extreme response to fallout from the 1990s bad-loans crisis, which government officials lacked the courage or foresight to address.

As financial cracks deepened, the BOJ in 2000 and 2001 devised the economic equivalent of a heart defibrillator to shock the system. The quantitative easing that then-Governor Masaru Hayami pioneered is still backstopping Japan’s economy 23 years later.

On Friday, current BOJ leader Kazuo Ueda had an ideal opportunity to begin taking the patient off life support. He didn’t, and the fact he demurred produced more questions than answers.

The financial media played along, making it seem like the BOJ did something big by allowing 10-year bond yields to top 0.5%. Around the globe, headlines declared that the BOJ had “shocked markets” providing “jolts” and sending “yields soaring.” Ignoring, all the while, that the yen was weaker after the BOJ’s mini-step than the one before it.

Does newish Governor Ueda think Japan Inc. is too fragile, 23 years later, to pull the monetary IVs out? Perhaps. Was he worried about pulling the rug out from under the Tokyo stock market, which recently hit 30-year highs? Maybe. Or did Ueda let politics cloud his judgement?

This latter point is worth considering as Prime Minister Fumio Kishida’s approval ratings fall back into the 30s. Kishida’s Liberal Democratic Party has led Japan with only two brief interruptions since 1955. Its modus operandi is to lean too hard on the BOJ to generate growth. And then to blame the central bank too much when the economy underperforms. It takes real gumption in Tokyo for a BOJ leader to act truly independently.

All this means that as economists implore China to learn the lessons of Japan, it’s not clear Japan has internalized the pros and cons of keeping the steroids flowing decade after decade.

It’s tantalizing to think where Japan might be today if 2003-2008 BOJ Governor Toshihiko Fukui had gotten his way.

At the time, Fukui decided it was time Japan lived without QE. He slowly and methodically pulled out the IV tubes. In 2006 and 2007, the Fukui BOJ managed to hike official rates twice. But politicians and corporate chieftains hated sobriety, complaining early and often. When a new BOJ leader arrived in 2008, zero rates were back.

In 2013, Governor Haruhiko Kuroda arrived at BOJ headquarters to supersize QE. Kuroda’s team gorged on so many government bonds and stocks that the BOJ’s balance topped the size of Japan’s $5 trillion economy.

Imagine, though, if Fukui’s rate normalization regime had survived. Politicians and chieftains would’ve been forced these last 16 or 17 years to implement structural reforms, cut red tape, increase innovation and productivity, take greater risks, modernize corporate governance, empower women, attract foreign talent and work to protect Tokyo’s status as Asia’s premier financial hub.

The BOJ’s willingness to up the dosage year after year took the onus off Japan Inc. to rekindle the animal spirits that once wowed the business world. This strategy, let’s admit, benefited China more than Japan. It also explains why upstarts like Indonesia are blowing Japan away in the race to produce tech “unicorn” companies.

Now here’s China being viewed through a Japanese lens amid talk of deflation. In Japan’s case, the anvil around the economy’s ankles was a mountain of bad loans suffocating the banking sector. In China’s case, it’s a troubled property sector weighing on demand, construction activity and overall confidence.

“Given that real estate and construction directly and indirectly contribute an estimated 20% of China’s GDP, the sector’s slowdown has led to talk that China may be suffering a balance sheet recession of the type that afflicted Japan in the years after the bubble economy burst at the end of the 1980s,” write analysts at Gavekal Dragonomics.

Balance sheets in the property sector, they add, “are contracting as falling sales, a structural slowdown in demand and a credit drought prevent developers from replacing completions with fresh presales in new projects. Considering the importance of the property sector to the overall economy in recent years, that will weigh heavily on aggregate demand. So, although the causes of China’s economic softness are not the same as Japan’s in 1990, the effects may not—ultimately—be so very different.”

All this falls to brand new People’s Bank of China Governor Pan Gongsheng to ensure that the economy avoids the “Japanification” destination to which many worry Asia’s biggest economy is headed. But as we learned from Japan—and Japan is still learning—you must fix the underlying problems, not just treat the symptoms.

Whether China goes the Japan route is anyone’s guess. Count Nobel laureate Paul Krugman among those who worry China will fare much worse. What’s clear, though, is that Japanification risks are haunting Tokyo as much as Beijing.