Covid-19 Brings Japan’s ‘Peter Pan Economy’ Down To Earth

Ask folks in Tokyo why Japan’s best expansion since the 1980s flopped and they’ll blame one of two things: the trade war or Covid-19. Some, of course, might guilt both.

But let’s be honest about the real culprit. It’s Peter Pan.

Don’t fault me for dragging J.M. Barrie’s beloved character into Japan’s deflation mess. None other than Bank of Japan Governor Haruhiko Kuroda did that in 2015 when he explained how he planned to reanimate Asia’s second-biggest economy.

Kuroda argued the key to the BOJ’s historic easing boosting demand was for tens of millions of Japanese to, essentially, believe in a little magic. “I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.'”

Five years on, the plan isn’t flying. Sure, President Donald Trump’s tariffs on China have been quite the subplot. And the coronavirus shock is surely upending Kuroda’s economy—and the global one, more broadly—in unpredictable ways. 

But Kuroda’s magic act wasn’t fooling us even before Trump began taxing steel, aluminum and more than $500 billion of Chinese goods. Neither wages nor inflation were rising markedly in the five years between 2013 and 2018, when Kuroda’s BOJ was firing his monetary “bazooka” in all directions.

The economy cratered 7.3% in the October-December period—well before Japanese businesses and consumers ever heard of Covid-19. Turns out, getting 126 million people to suspend disbelief requires more than talk. It requires more than adding conventional credit to an aging and uncompetitive economy.

This realization finally hit Kuroda, who in recent days appears to have dropped the act. Last week, Kuroda for the first time since assuming the BOJ governorship in 2013 dispensed with the fairy-tale talk. He talked realistically about slowing growth to come.

Just as important, he flipped the script from which the BOJ has been reading under Prime Minister Shinzo Abe. All along, the focus has been on meeting a 2% inflation target. To get there, Kuroda’s team hoarded half of all government bonds, cornered the stock market via exchange-traded funds and pushed into any number of other assets.

These efforts warped bond trading and propped up stocks, but didn’t catalyze the virtuous cycle Abe and Kuroda previewed. Trickle-down economics, in other words, failed us again. What’s missing is the structural reform big bang Abe promised in 2012.

Abe pledged to loosen labor markets, incentivize innovation, cut bureaucracy, empower women, raise productivity and internationalize corporate governance. He slow-walked these and other upgrades. The absence of clear change left Japan Inc. CEOs reluctant to share corporate profits with workers.

Tokyo has been involved in a staring contest. Abe and Kuroda believed epic BOJ stimulus and weaker a yen would shock the system. CEOs saw it as a nice opening, but what’s next? Turns out, CEOs are skeptical of an Abe-Kuroda reform team that never really grew up.

Kurodanomics needs a sequel, and a splashy one at that. The BOJ can produce one by expanding asset purchases to other assets. It could recalibrate government bond purchases to help banks, particularly regional ones, increase credit growth. It could buy mountains of local-government debt to give municipalities greater fiscal space to invest in job creation.

The BOJ could ask lawmakers to empower it to engage in a quid pro quo with large companies: the central bank could buy debt from companies pledging not to lay off workers. And make even bigger purchases from companies willing to raise wages.

Kuroda’s team could work with the Ministry of Finance to devise ways to get more cash into consumers’ hands. The specifics of Abe’s $2.2 trillion of public spending are opaque and focused on corporate giants. Why not allow the BOJ to spearhead a temporary universal basic income scheme?

The time of trying to bamboozle the masses with theatrics and Disney-level happy thoughts has passed. With inflation seen average -0.5% relative to the 1% gain the BOJ previewed in January. A Reuters poll of economists expects a 27.2% drop in annualized gross domestic product in the April-June quarter.

It’s clear what Kuroda had been trying to do. There’s a bit of hocus pocus to the central banking game. That’s doubly so when you’re trying to alter a “deflationary mindset” decades in the making. Yet Japan’s $5 trillion economy put too much faith in happy talk. At some point, Kuroda must examine why Japan is still grappling with deflationary pressures—and recalibrate accordingly.

There’s still scope for the BOJ to do just that. To change the script and wow investors, businesspeople and Japanese households, Kuroda must recalibrate his policy mix and get more creative. At the moment, though, Kuroda and his team seem stuck in, well. Neverland.

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