Japan and the Monetary Policy Magical Mystery Tour

By Richard Westra

With 1970s galloping inflation threatening to bring down the US economy and with it the US dollar based global trading order, Milton Friedman proved correct in his policy advice that rapidly curtailing the money supply and restricting credit creation would halt the rot. But as Japan is painfully discovering, monetarist faith that following the opposite course will raise price levels to resuscitate growth is a fool’s errand.

When Milton Friedman acolyte Ben Bernanke was a Professor at Princeton University, he had lectured Japan during a 2000 visit on the role of monetary policy in combating deflation. Bernanke, weighing in on what was then Japan’s first so-called “lost decade”, opined: “monetary authorities can issue as much money as they like…money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero”.1 Bernanke, like Friedman, however, holds two problematic assumptions about “money issuance” which, in the end, serve to vitiate this simple story. Firstly, there is the important question of the difference between “commodity money” of 19th century financial systems and current state “fiat money”. Secondly, Friedman and Bernanke never imagined structural impediments materialising to thwart “supplied” money from being “activated” in the “real” economy. Let us treat these as a prelude to exploring the predicament Japan faces in the global economy today.  

Global finance under the commodity money gold standard engendered a seamless integration of international, national and local monetary relations of states connected to its trading order with central banks superintending unrestricted import and export of gold, which national currencies were fixed to. The state had no policy role in regulating the money supply. The gold reserve of each country, secured in respective central bank vaults, constituted the foundation for both credit creation by commercial banks and the “legal tender” or banknotes issued by the central bank. Money issuance, whether for discounting bills of exchange or to meet cash payment needs, occurred “automatically” in response to ebbs and flows in buying and selling of goods. If defaults hit an economy, gold reserves were drained from central banks besetting economies with deflation and austerity until gold stocks were replenished.

Under fiat money regimes marking economies from the 1950s, and the global economy with the 1971 demise of Bretton Woods, state debt security IOUs serve as monetary reserves. It is the holding of these government securities or bonds between the central bank and commercial banks connected to it that determines the level of the “monetary base” and extent of credit creation in the economy. Crucially, the role central banks play in fiat money regimes’ buying and selling securities to grow or shrink the monetary base conjures up the notion of central bank “independence” with the illusion that money issuance is solely a matter for “monetary authorities”. However, unlike the gold standard, the arrival at an “optimal” supply of money in fiat money regimes can only be achieved through state policy. It is simply the case that states delegate to central banks the power to determine the level of the monetary base – which is itself a state policy decision. It is precisely the need for maintaining policy flexibility which moved major economies in the post World War II (WWII) period to abandon the gold standard.2      

Our second question, of money pooling “idly” in the financial system, and not being “activated” in real economic activity, is something Friedman and Bernanke along with the whole mainstream economics profession never countenanced. As has been strongly emphasised of late, neoclassical macroeconomic theory blithely assumes saved funds will always be borrowed and spent, and never problematises the financial system in its models.3 From the perspective of Marxian economics, however, the very efficiency of capitalist economies required banking systems play a “capitalist social” role. That is, in capitalist economies, the banking system holds funds rendered temporarily “idle” by businesses during the course of business cycles. Idle money deposited by a particular business is then made available to any business to realise profitable investment opportunities or to commercial capital which purchases goods wholesale, clearing inventories and enabling rapid reinvestment of profits.

Larger pools of idle money begin to accumulate in capitalist economies during the post WWII period of corporate capitalist production of consumer durables. On the one hand, the sheer extent of corporate profits, which allowed corporations to finance expansion with minimal bank borrowing, left ample funds in banking systems to finance welfare states and, in the case of the United States (US) in the 1950s and 60s, covet global assets. On the other hand, exigencies of financing the consumer durable production edifice with its long term expensive investments in fixed capital, required corporations to become “money managers”, to adopt Hyman Minsky’s term. Central banks then necessarily put their policy apparatus on alert to provide liquidity injections in the face of potential shocks exacerbating this system’s inherent “fragility”.4  

Japan’s Miracle Economy Saves the World

What is often referred to as the post WWII “golden age”, which commenced in the US in the 1950s and spread to Western Europe and Japan in the subsequent decades, fell into crisis during the course of the 1970s. Large pools of idle money soon morphed into bloating oceans of funds with no possibility of ever being converted into real capital to be invested in production centred activity. The obverse to the foregoing, the disintegration of full-scale integrated industrial production systems and their disarticulation across the globe to low wage locales, also commences in the US economy. Japan, however, though confronted by the same global crisis malaise, rapidly reinvented itself. Four keys to its reinvention were: a) Japan’s mode of corporate financing of plant and equipment where bank allegiance to business groups cocooned companies from pitfalls of excessive long-term debt obligations; b) Japan’s penchant for Keynesian deficit spending long after it fell out of favour in the US; c) Japan’s rapid increase in labour productivity through early introduction of microelectronic information and computer technologies; and d) Japan’s expansion of exports under conditions of continued growth in international trade.5  

Riding a wave of export prowess, Japan generated its own ocean of idle money, significantly exceeding domestic investment needs of its consumer durable economy, leading to its rise as the world’s foremost creditor nation, eclipsing the US by 1986.

Riding a wave of export prowess, Japan generated its own ocean of idle money, significantly exceeding domestic investment needs of its consumer durable economy, leading to its rise as the world’s foremost creditor nation, eclipsing the US by 1986. In the several years following the demise of the US golden age economy, the coveting of foreign assets by Japan outpaced by 20 percent the earlier US spree of over two decades. To be sure, Japanese companies also engaged in shifting components of their production and assembly operations overseas, particularly to Southeast Asia. But this occurred under conditions where Japan continued to build up domestic manufacturing capacity, thus industrial employment in Japan experienced no decline until 1994.

For its part, the US adopted an entirely new orientation that parlayed the role of the dollar as world money into a position in the global driver seat akin to when it was a global creditor and manufacturing workshop. Wall Street developed into the command centre for managing global finance in the increasingly liberalised, deregulated world the US compelled.

Notwithstanding parlaying the role of the dollar as world money into global suzerainty, US policy makers looked askance at Japan’s industrial might. Their ploy to address it was a negotiation among major economies to strengthen the yen. Japan dutifully acceded to the Plaza Accord in 1985, yet what amounted to one of the great currency revaluations in history had no effect on the US trade deficit. What it did impact was global confidence in the US dollar and its Treasury backing at a time of global financial market opening and where the US depended upon world savings in dollar denominated instruments to ensure its global predominance. However, as Black Monday, October 1987 crisis shook the world, with the US suffering its then greatest stock market crash, Japan was persuaded to leap in and gobble up US Treasury IOUs even as they were being dumped across the globe.

To incentivise its flush institutional investors into streaming savings to US dollar instruments, Japan slashed domestic interest rates. The domestic economic ramifications of inordinately low interest rates were cataclysmic. This was particularly the case given Japan’s unique mode of corporate finance. Hence a spending bonanza spread like wildfire through the economy drawing in even small savers and landowners as every imaginable asset class value inflated into a monstrous bubble as legendary as the government bailout, which followed.6

Internationally, with US and Wall Street compelled deregulation and liberalisation prying open remaining “dirigiste” East Asian economies like South Korea, low interest rates on the yen set off a “carry trade” in which yen borrowing fuelled speculative excesses that fomented the Asian Crisis of 1997-98. With financial villains of that piece bailed out by US taxpayers, funds flooded back into Wall Street coffers just in time to feed the borrowing frenzy of the dot com bubble.7

Japan did save the world from Black Monday. However it was a world being increasingly remade in the image of the US economy or “financialised”. Bank for International Settlements economist Claudio Borio shows, for example, that Black Monday 1987 began a trend in which pronounced financial cycles of speculative bubbles and bursts supersede real economy business cycles in the US economy.8 The US dollar as international money and Wall Street constituted as the vortex through which the world’s idle funds are dispatched on speculative endeavours is the transmission mechanism for this trend into the global economy.

Japan and the Enchanted World of Quantitative Easing

The US originated global meltdown of 2008-2009 along with subsequent global tremors sent the US government and Federal Reserve (FED) into overdrive bailing out major financial institutions to avert outright economic collapse. This time it was not Japan but China which saved the world. It is estimated that global demand generated by China’s massive spate of state sponsored infrastructure spending drove 40 percent of global growth between 2008 and 2010.9 However, that China’s economy had this impact due to vast dollar accumulations from its role as a global assembly hub for consumer goods is in many ways symptomatic of all that is wrong with the global economy. After all, the disintegration of global production systems and the outsourcing of manufacturing operations to low wage locales lower investment costs for corporations leaving them with more idle funds to play money games or disburse as “shareholder value”.10

Japan, to be sure, played a major part here. Its large foreign investment presence in China and Southeast Asia places it at the centre of a network of disarticulated production systems which reconfigure global trade in manufactures toward “intermediate goods”. Where Japan reinvented itself once again in the early 21st century resides not with its internationally recognised brand champions (with the exception of Toyota), but with a new breed of high tech manufacturers such as Keyence and Fanuc that produce indispensable components for everything from robotics to Dreamliner jets and iPhones along with the capital goods for their production.11

However, the world’s problems, and Japan’s, run deeper. Persisting recession (or in Orwell speak, “the recovery”) in major economies in the second decade of the 21st century unleashed the peculiar monetary policy known as quantitative easing (QE). Perversely, what QE is responding to is the fact that oceans of idle funds outstripping investment needs of real economies have been sloshing across major economies and the globe for decades engaging in leveraged, debt fuelled money games. The US and Wall Street battened upon the wealth effects of this excrescence in rising stock market and other asset values with other major economies feeding at the trough. When financial bubbles burst governments saddled publics with bills for distressed assets and refurbished banking systems by stocking their monetary base through QE.

From 2008 to 2014 the FED, European Central Bank, Bank of England and Bank of Japan (BOJ) expanded their collective monetary base by $6 trillion.12 Today, if we add in to the foregoing liquidity injections of the Swiss National Bank and Peoples Bank of China, central bank balance sheets hold around $18 trillion equal to almost 40 percent of the combined GDP of these economies.13 Japan’s QE, ubiquitously referred to as QE on steroids, has seen BOJ balance sheet leap to a staggering 80.6 percent of Japan’s GDP.14 Ostensibly, the purpose of QE, when paired with government manipulation of interest rates to near zero, is to promote confidence among commercial banks to lend to businesses under circumstances where deleveraging continues to write down earlier debts. But commercial banks see no opportunities for profitable credit creation and have parked their reserves with the central bank prompting central banks to turn to the device of “negative interest rates” to force commercial banks to lend. A full $5.6 trillion of Japan’s government debt now trades at below zero.15

Economist Richard Koo has famously dubbed the condition where only governments are left to borrow and spend a “balance sheet recession”.16 He rightly maintains that QE will not spark growth but simply contribute to the swelling of idle balances as per this article. Koo thus advocates more government fiscal spending while the private sector rejuvenates. The problem with this is not, as commonly claimed, the ponderous size of Japan’s debt reaching 250 percent of GDP. Japan continues to be the world’s major creditor economy with a net international investment position of well over $3 trillion and the Japanese government owns extensive financial assets which place Japan’s real debt around 130 percent of GDP. As well, Japan’s net interest payments on its debt as a percent of GDP are the lowest among G7 economies.17 The problem is where to spend!

The belief that a weakened yen to help overseas sales of Japanese cars and flat screen TVs while spending on roads and bridges at home to cajole private companies to borrow and spend the Himalayan idle balance is misguided.

Bloating oceans of idle money streaming into bubble fomenting casino play rather than real economy investment which generates incomes or “active” money has been the harbinger for decades now of the exhaustion of the post WWII consumer durable economy with its petroleum energy matrix. Disintegration and disarticulation of domestic integrated production systems euphemised as “globalisation” offered temporary economic respite.Government spending of 38 percent of GDP in the US and 42.1 percent in Japan in 2014 has maintained this world on life support.18 The belief that a weakened yen to help overseas sales of Japanese cars and flat screen TVs while spending on roads and bridges at home to cajole private companies to borrow and spend the Himalayan idle balance is misguided.

Currently, if state spending is to have any lasting impact it must partner with businesses it has saved to substantively remake the Japanese economy around new technologies and power sources. Remember, fiat money regimes were brought into being precisely to operate social democratically with such policy flexibility as opposed to the gold standard the only policy outcome of which was austerity. The inventiveness and social cohesiveness of Japan is there. But missed opportunities abound as the follow up to the Fukushima Daiichi nuclear disaster demonstrates.

About the Author

westra-webRichard Westra received his PhD from Queen’s University, Canada in 2001. He is author or editor of 14 books. His work has been published in numerous international peer reviewed journals. He is co-editor of Journal of Contemporary Asia. His most recent single authored book is Unleashing Usury: How Finance Opened the Door to Capitalism Then Swallowed It Whole (Clarity Press, 2016).


1. Bernanke, B., “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” in Mikitani R., and Posen A. (eds.), 2000 Japan’s Financial Crisis and Its Parallels to the U.S. Experience, Institute for International Economics, , p.158.

2. Sekine T., “Fiat Money and How to Combat Debt Deflation”, in Yagi K., et al. (eds.) 2012, Crises of Global Economies and the Future of Capitalism, Routledge.

3. Koo R. C., 2016, “The Other Half of Macroeconomics and the Three Stages of Economic Development”,http://www.paecon.net/ PAEReview/issue75/Koo75.pdf.

4. Sekine, “Fiat Money and How to Combat Debt Deflation”.

5. See on this and what follows, Westra R., 2012, The Evil Axis of Finance: The US-Japan-China Stranglehold on the Global Future, Clarity, Chapters 2, 4 and 5.

6. Murphy R. T., 2014, Japan and the Shackles of the Past,Oxford University Press, pp.183ff.

7. Wincoop E. van and K-M Yi, “Asia Crisis Postmortem: Where Did the Money Go and Did the United States Benefit?” https://www.newyorkfed.org/medialibrary/media/research/epr/00v06n3/0009vanw.pdf.

8. Sauga M. and Seith A. “Out of Ammo? The Eroding Power of Central Banks”, http://www.spiegel.de/international/business/central-banks-ability-to-influence-markets-waning-a-964757.html.

9. Bloomberg View, “China’s Fall, Not Rise, Is the RealGlobal Threat”,http://www.bloomberg.com/news/2011-10-04/china-s-fall-not-its-rise-is-the-real-threat-to-the-global-economy-view.html.

10. Milberg W. and Winkler D., 2013, Outsourcing Economics: Global Value Chains in Capitalist Development, Cambridge University Press, pp. 210ff.

11. Murphy, Japan, pp. 205-8.

12. Economist Intelligence Unit, “The end isn’t nigh: Central Bank Challenges as the Era of Cheap Money Enters a New Phase”, 2013, http://www.eiuresources.com/EndOfCheapMoney/.

13. Durden T., “How Central Banks Are LBOing The World In One Stunning Chart”, http://www.zerohedge.com/news/2016-09-05how-central-banks-are-lboing-world-one-stunning-chart.

14. Bloomberg, “What’s Wrong With Japan’s Economy?” http://www.bloomberg.com/graphics/2016-japan-economy/.

15. Wall Street Journal, “Japan’s Negative-Rate Experiment isFloundering”,http://www.wsj.com/articles/japans-negative-rate-experiment-is-floundering-1460644639.

16. Koo, “The Other Half of Macroeconomics and the Three Stages of Economic Development”.

17. Economist, “Japan’s economy: Three-Piece Dream Suit”, http://www.economist.com/news/finance-and-economics/21702756-abenomics-may-have-failed-live-up-hype-it-has-not-failed-and

18. https://data.oecd.org/gga/general-government-spending.htm.


The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.