A thorough dissection of the Black Monday that originated in Japan and how to properly learn its lessons
Will the next Black Monday originate in Japan? Or in the United States?
Saturday, August 31, 2024
A bolt from the blue: the Black Monday that originated in Japan on August 5th
Any sensible citizen or investor should not lightly forget the sudden re-emergence of the midsummer Black Monday that occurred on Monday, August 5th, 2024.
Regarding this Monday's market crash (Black Monday), which was a bolt from the blue that undoubtedly originated in Japan, there has been a lot of superficial and shallow reporting, and in the end, there seem to be a number of unfair experts who seem to belittle its significance and even wish to bury it in oblivion. As I will explain later, it is very unfortunate, but it seems that Bank of Japan Governor Ueda is one of them.
Therefore, this August Monthly aims to thoroughly dissect the midsummer Black Monday that originated in Japan and to correctly learn the lessons from it. In particular, we will explain below how such an unprecedented crash is likely to be repeated, and how we can protect ourselves from a catastrophe, whether it originates in Japan or the United States in the international financial market.
In addition, if a Black Monday originates in the United States, rather than a Black Monday originating in Japan like this one, we will objectively show the risk that about 1,500 trillion yen of wealth, which is much more than twice the size of the Japanese economy (nominal GDP) of about 600 trillion yen, will be instantly wiped out in the U.S. stock market.
In addition, this Monthly Supplement also outlines the "power and appeal of Nikkei 225 futures and options," which is essential to discussing the trends of Japanese spot stocks.
By the way, although it was a Black Monday originating in Japan that temporarily shook the global economy and international financial markets, fortunately, both Japanese and U.S. stock prices showed a rapid recovery toward the end of August.
In particular, the NY Dow Jones Industrial Average continued to hit record highs day after day toward the end of August, as if enjoying the end of this summer ahead of the Labor Day holiday on Monday, September 2nd, mainly due to expectations of a US interest rate cut at the next FOMC meeting scheduled for Thursday, September 19th.
The Nikkei Stock Average also generally followed the US stock market and rose upwards, and the closing price of the Osaka Securities Exchange Nikkei 225 futures at 6 a.m. on Saturday, August 31st, was 39,060 yen, surpassing the Heisei bubble high (about 39,000 yen) once again, as if the market wanted to forget all about the nightmare of Black Monday that originated in Japan this summer.
However, if we look at the monthly chart of the Nikkei Stock Average and the dollar-yen exchange rate (above), we can see that both Japanese stocks and the Japanese yen ended August with negative lines, and it is an undeniable fact that the deep scars of Black Monday that originated in Japan on August 5th continue to be engraved.
In any case, if the recovery trend seen towards the end of August continues in the September market, which starts next week on Monday, September 2nd, the yen carry trade, which was completely crushed on August 5th by selling the low-interest yen and buying risk assets such as the high-interest US dollar, will pick up steam again, and the clear, autumn skies are likely to continue.
However, this may just be a mirage. That is because, in order for the bulls to turn things around and win in the September market, even though the international financial markets have almost 100% factored in expectations of a US interest rate cut in September, they will have to easily clear one hurdle after another before the next FOMC meeting, including the US August employment statistics scheduled for release on Friday, September 6th, as well as the US August CPI scheduled for Wednesday, September 11th.
Chairman Powell made this claim at the annual Fed Seminar (Friday, August 23rd) held every summer in the picturesque Jackson Hole, Wyoming, and the market has come to believe it, but is a September rate cut a certainty, and are the major economic indicators in the near future just an easy obstacle?
At the very least, I am skeptical, and I am concerned that not only does Powell's Fed have an Achilles heel in the form of a neutral interest rate that is too low, but that the so-called wealth effect, which is too strong, may soon begin to damage it (for details, please refer to the author's July Monthly from last month).
Nikkei average stock price falls by 4,451 yen, the largest drop since Black Monday
As I emphasized at the beginning, the main theme of this August Monthly is a thorough dissection of Black Monday, which originated in Japan and occurred on August 5th, which was a bolt from the blue. This introduction has become too long, but let's take a closer look at it below.
"The Nikkei average fell sharply on the Tokyo Stock Exchange on August 5th, closing at 31,458 yen, down 4,451 yen (12%) from the previous weekend. The fall was the largest ever, surpassing the 3,836 yen fall on October 20, 1987, the day after Black Monday, when the sharp fall in U.S. stocks spread around the world," the Nihon Keizai Shimbun reported in its morning edition the following day (August 6th), accurately describing the dire situation.
At the same time, the newspaper also vividly reported that "The Nikkei average also fell the second-worst in history, hitting its lowest closing price in about nine months since October 2023." For example, the newspaper reported that "More than 800 stocks across Japan, including Sumitomo Mitsui Financial Group, Dai-ichi Life Holdings, and Tokyo Electron, fell to the lower limit of the price range (stop-down level)."
In fact, the Osaka Exchange had to implement an unusual measure to encourage investors to make calm decisions at the time of sudden market fluctuations by activating a "circuit breaker" to temporarily suspend trading in Nikkei 225 futures at around 1:30 pm on August 5th, as the decline from the previous weekend reached the limit of 8%. Selling continued to lead to more selling, and the circuit breaker was activated again at around 2:30 pm on the same day, the article calmly reports on the serious situation in the Japanese financial market at the time.
In any case, while investors who held physical stocks for a long time were not so bad, short-term speculators who had leveraged their stocks through margin trading were forced to make margin calls due to the sudden market crash, and many of them were forced to sell off their stocks, resulting in huge losses.
Black Monday on August 5th did not originate in the United States but in Japan.
However, on Friday, August 23rd, a closed session was held in both the House of Representatives and the House of Councillors on the topic of the financial market, which has experienced such historic volatility. In his first public appearance since the market turmoil, Bank of Japan Governor Ueda stated, "The market remains unstable, and we will be watching it with a high level of tension." It is only natural that he stated, "The stock market crash was largely due to the US employment statistics released on the 2nd falling short of market expectations, which intensified concerns about a US economic recession." It is truly regrettable that he seemed to be shifting the blame for the Bank of Japan to the poor performance of the US economy.
Because the unprecedented catastrophe for the international financial market, the crash of Japanese stocks and the sudden appreciation of the yen that occurred on August 5, 2024, is, in short, nothing more than a reversal of the yen carry trade, which had been continuing until then, in which the low-interest yen was sold and the high-interest US dollar and other risk assets were bought. If that is the case, then wouldn't the Bank of Japan's monetary policy itself be at the heart of the Black Monday crash of August 5th?
Moreover, rather than being a deja-vu of the infamous Black Monday that broke out in the US in October 1987 (when stock markets around the world crashed by more than 20% in one business day, while Japanese stocks were an exception and only fell by about 15%), the biggest feature of this summer's Black Monday is that it originated in Japan.
The first reason why we can conclude that this Black Monday originated in Japan is that the degree of the crash in Japanese stocks was clearly more severe than that of US stocks.
For example, this Black Monday that originated in Japan did indeed record a sharp drop of minus 12.4% on the day of the crash, Monday, and the cumulative drop in the Nikkei 225 over the three business days from Thursday, August 1st to the following Monday was minus 20.8%.
In contrast, in trading on Friday, August 2nd, the week before Black Monday from Japan, US stocks fell in response to the July employment statistics released that morning, which were slightly lower than market expectations. However, the Nasdaq Composite Index, which has a high correlation with the Nikkei Stock Average, only fell by 2.4% in one business day. The cumulative decline in the Nasdaq Composite Index over the three business days from Thursday, August 1st to Monday, August 5th was only 8.2%. These declines in US stocks were not necessarily small "mini-shocks," but they were by no means comparable to the cumulative decline of the Nikkei 225, which fell by 20.8%.
Secondly, at the same time as Black Monday from Japan, the yen against the dollar rose sharply to the 141 yen range at one point in the Tokyo foreign exchange market. In other words, the acceleration of the "yen buying, Japanese stock selling" trend was another major feature of Black Monday from Japan.
Thirdly, on Thursday, July 31st, just before the three consecutive business days of the Japan-originated Black Monday crash, the Bank of Japan decided to raise interest rates further to 0.25%. In addition, at the regular press conference following the Bank of Japan's monetary policy meeting, Bank of Japan Governor Ueda expressed a fairly positive attitude toward continuing further interest rate hikes in the future. It is not at all unnatural to see these as the fuse that led to this summer's Japan-originated Black Monday crash in Japanese stocks and the sudden buyback of the Japanese yen.
Fourthly, on Friday, August 1st, the day after the Bank of Japan meeting, the Federal Reserve decided to maintain the current policy interest rate at the FOMC (Open Market Operations Committee), which decides US monetary policy. However, at the regular press conference immediately afterwards, Fed Chairman Powell quite clearly hinted at the possibility of a rate cut at the next FOMC meeting in September.
Indeed, the strong hint by the chairman that the US interest rate would be cut in September would likely lead to a weaker dollar and a stronger yen, and in fact, the foreign exchange market reacted in that way. However, a cut in US interest rates would be expected to contribute to US employment expansion and sustainable economic growth, so it is quite difficult to see Chairman Powell's suggestion of a rate cut as the direct cause of the US stock market's sudden drop in Japanese stocks the following Monday, as the US stock market fell just because of the US employment statistics.
For example, in early August, the well-known US economist Professor Paul Krugman said, "The US stock market decline is not due to US employment statistics, but contagion from the fall in Japanese stocks," and added, "Never believe the media's explanations of stock market movements," and then, "Weak employment reports can lower long-term interest rates and push up (US) stock prices (which is what happened)." He also tweeted, "Was this contagion from Japan?" in a timely manner, which was quite impressive.
Thus, the Black Monday of August 5, 2024 (a stock market crash on a Monday) can be seen as a Black Monday originating in Japan, in the sense that the hawkish stance of Japan's financial authorities, which suggested an additional interest rate hike to 0.25% and continued interest rate hikes in the future, brought about the Japanese stock market crash accompanied by a buyback of the Japanese yen.
The Bank of Japan's additional interest rate hike is a perfect behind-the-curve move
In any case, it must be said that it is too late for the Bank of Japan to rush to normalize monetary policy until around the summer of 2024, when Japan's inflation begins to exceed the target of 2%, rather than in early spring 2022, when the FRB begins to raise interest rates significantly and continuously at roughly the same time.
In fact, not only have we allowed inflation to exceed 2% for over two years, but we have also allowed the dollar to appreciate and the yen to depreciate dramatically from about 108 yen to the dollar, which is considered purchasing power parity, to as low as 162 yen at one point, and on the other hand, we have allowed the stock bubble to grow, with the Nikkei average not only far exceeding the Heisei bubble peak of about 39,000 yen, but also soaring even further to the 42,000 yen level. As a result, Japan's policy authorities, led by the Bank of Japan, have become completely unable to control inflation, currency, and stock bubbles.
As a result of amplifying the yen carry trade, which involves selling the low-interest Japanese yen and buying a wide range of risk assets such as the high-interest US dollar, the Japanese Ministry of Finance finally repeated large-scale unilateral covert foreign exchange interventions intermittently after Showa Day (29th), a national holiday in April 2024, and the long-awaited additional interest rate hike by the Bank of Japan on July 31st triggered a sudden and huge reversal of the extreme yen carry trade that had been continuing until then, causing Black Monday originating in Japan on August 5th.
Make no mistake. This is not a Black Monday originating in the United States like in 1987, but a Black Monday in midsummer on August 5th, 2024, originating in Japan.
By the way, the Bank of Japan has practically abandoned its role as the guardian of prices and currency for the people, and it seems to have become a watchdog for the Japanese government and the Ministry of Finance. Although the Bank of Japan Act was formally revised in 1997 since Saburo Shiroyama's famous novel "The Bank of Japan," the reality has hardly changed at all, and it must be said that the Bank has not learned any lessons from the past.
In any case, while it seems that the Bank of Japan is finally beginning to clarify its stance of continuing to raise interest rates, on the other hand, the US Federal Reserve has now clearly shifted to a stance of lowering interest rates, as if it were blind to its own Achilles heel.
As a result, the huge contradiction between the monetary policies of Japan and the US will grow even larger, and in the future, some kind of negative news in the international financial markets could trigger another catastrophe that was even more severe than the Black Monday that originated in Japan on August 5th.
At a time when asset bubbles in stocks, housing, and other assets appear to be about to expand in the United States on the back of expectations of a U.S. interest rate cut, there is no denying the risk that if the United States sneezes, the Japanese economy and its financial markets could fall into a more serious illness than just pneumonia.
Are stock prices predictable?
By the way, are stock prices predictable? Can you make money from stock investment? The biggest challenge in this regard is the repeated creation and collapse of bubbles.
Why do bubbles occur and why do they collapse? Even if the cause can be identified, can it be predicted?
After all, can you escape a crash? If you can't escape, you may not make a profit, but may suffer a huge loss. No, you may be crushed by the market.
The stock market crash on Monday, October 19, 1987 was undoubtedly the most dramatic event in postwar financial history. The Dow Jones Industrial Average (DJIA) fell 508 points, or minus 22.6%, from $2,247 to $1,739 in just one day.
This Wall Street crash, Black Monday, shocked the world. The Nikkei average stock price also fell by 15.6% on the following Tuesday. Of course, it was the worst one-day drop in Japanese stocks in history, but it was still the smallest drop among major markets. This was probably because it was the era of "Japan as Number One" at the time, and the high growth of the Japanese economy was expected to continue.
However, it should be noted that the Heisei bubble collapsed in Japan three years later. In any case, the New Zealand market crashed by about 40%. The Hong Kong stock market was closed down due to a large number of defaults in the futures market caused by the fall in stock prices.
At the time, the US market capitalization was said to have been wiped out by $500 billion (approximately 50 trillion yen), but if a crash of the same scale were to occur in the US in 2024, it would destroy 1,520 trillion yen (US stock market market capitalization as of the end of 2023: approximately 7,600 trillion yen x minus 20%), an enormous amount of wealth (US stocks), more than twice the size of Japan's nominal GDP (approximately 600 trillion yen). In this way, the (original) Black Monday of 1987 in the US was a truly enormous crash.
(Note that the market capitalization of Japanese stocks as of August 2024 is approximately 950 trillion yen. If the Japanese Black Monday were to fall by 20% in one business day, approximately 190 trillion yen of Japanese wealth (Japanese stocks) would be destroyed.)
In any case, it is safe to say that this original Black Monday actually began at least the week before Monday, October 19, 1987.
At 8:30 on Wednesday last week, the US Commerce Department announced that the US trade deficit had ballooned to a size far beyond market expectations. Financial markets reacted immediately. For the first time since November 1985, long-term government bond yields had exceeded 10%. And the dollar was heavily devalued in the foreign exchange market. The situation worsened further on Thursday and Friday, and at the close of Friday, there was a large amount of selling in stock index futures.
Against this backdrop, Black Monday and the subsequent "Terrible Tuesday" occurred, and the market practically collapsed. The New York Stock Exchange did not close, but 200 stocks were forced to suspend trading. Trading of the S&P 500 futures in Chicago was also halted.
The only futures market that remained open was the Major Market Index, the blue-chip index of the Chicago Board of Trade (CBOT). Seeing that this Major Market Futures Index had fallen so low, buyers returned to the futures market.
And the US central bank, the Federal Reserve, led by Greenspan, who had only just become chairman in August of that year, continued to supply a large amount of liquidity to the financial system, encouraging a reversal in stock prices. This worked, and a meltdown in the US and global financial markets was averted.
Why did Black Monday happen?
There are basically two interpretations. One is from the perspective of emphasizing the efficiency of the stock market, and the other focuses on the irrationality of the market. Malkiel of Random Walker, a representative of the former, explains the cause as follows:
First, in the two months up to mid-October, US long-term government bond yields rose from about 9% to 10.5%. Second, in the first two weeks of October, Congress threatened to impose a merger tax, which increased the risk of investment. Third, then-Second, then-Secretary of the Treasury Baker hinted at further depreciation of the dollar, which discouraged investment not only from domestic investors but also from foreign investors. Finally, he said that while it is difficult to link daily stock price movements to specific news, it is not unreasonable to think that a number of bad fundamental events accumulated and led to the big crash in mid-October.
Malkiel also presents an interesting numerical example in his book, using the Gordon model of stock prices, showing that a Black Monday-like crash can be rationally explained even when interest rates rise from 9% to 10.5% and the long-term growth rate of dividends remains unchanged. Of course, if expectations for growth fall, stock prices will fall further.
I consider Malkiel's explanation based on market rationality to be quite persuasive. However, I must say that it is insufficient in that it ignores the important issue of the failure of international policy coordination in the areas of foreign exchange and monetary policy, as described below.
Furthermore, with an explanation based solely on rationality like his, the market could rise and fall every day just because of slight changes in expectations for interest rates, equity risk premiums, and growth rates. This would be unrealistic. In other words, while there are some persuasive aspects to this theory, it must be said that it is an insufficient explanation for the bubble.
In response to this, Robert Shiller (Nobel Prize winner in Economics), author of Irrational Exuberance and one of the leading figures arguing that markets are irrational, summarizes the causes of the stock market crash on Black Monday as follows:
First, stock prices were overvalued before Black Monday. Second, there was a concentration of risk hedging by institutional investors, such as program trading, stop-loss orders, and portfolio insurance. Third, investor irrationality. The crash was simply caused by investors panicking and a sudden decline in investment sentiment.
In other words, investors, in the midst of panic and tension, had no choice but to look for what other investors would do and rely on intuitive models such as stock price recovery and stock price trend continuation. In such a situation, a feedback system is formed and there is no need to mention triggers that cause the crash.
Shiller's interpretation is excellent in explaining what was actually happening in the stock market in the midst of the crash. However, it must be said that it is insufficient to simply attribute the cause of the crash to changes in investor sentiment. This is because it does not explain why such a large change in sentiment occurred. Moreover, if the trigger for the crash is not found in fundamentals, it will be impossible for investors to find a way to avoid it.
Is that really the case?
The author believes that it was the failure of the exchange rate target zone concept associated with the Plaza Accord and the Louvre Accord, and the sudden change in investment sentiment that it brought about.
And of course, index futures trading and other transactions acted as a catalyst and lubricant to transform this downturn into a crash.
After adjusting the dollar-yen rate in April 1987, the target exchange rate zone concept agreed upon in the Louvre was successfully maintained for several months. However, the US current account deficit further expanded, and dollar selling pressure continued. Therefore, it was clear that the currency target zone concept could only be maintained if the US tightened its monetary policy and dollar asset interest rates exceeded foreign interest rates. Financial markets were suspicious that stabilizing the value of the currency would actually cause the US economy to fall into recession.
With the currency system in such a state of flux, Greenspan took over as chairman of the Federal Reserve on August 11, 1987, replacing Volcker. As the market feared, the new chairman raised interest rates immediately after taking office in order to prevent the dollar from continuing to fall due to the Louvre Accord. This was the background to the US long-term government bond yield exceeding 10% as mentioned above.
Then, the US's critical stance against Germany's subsequent additional interest rate hikes reminded people of the failure of the Louvre Accord, and fears that the Fed would be forced to raise interest rates further to defend the dollar rapidly grew in the financial markets.
Black Monday, Monday, October 19, 1987, thus occurred over the fundamental contradiction in the international policy coordination between the Fed's monetary policy, the US government Treasury's exchange rate policy, and the German authorities.
Concerns about rising interest rates and economic recession. A bend in expected growth rates. It is believed that future expectations regarding such economic fundamentals have greatly increased. The deterioration of investor sentiment and the massive and concentrated selling of index futures to secure portfolio insurance were merely catalysts that amplified the market's suspicions. However, it goes without saying that once overvalued stock prices plummeted and selling pressure intensified, a positive feedback mechanism was at work, where selling begets selling.
In any case, Fed Chairman Greenspan continued to supply a large amount of liquidity to the financial system, encouraging a reversal in stock prices. Other central banks followed the Fed's lead. And interest rates around the world fell. These measures worked, and a meltdown of the U.S. and global financial markets was averted. However, at the same time, the policy of stabilizing the dollar by maintaining the domestic and foreign interest rate differential was completely abandoned. The dollar fell far below the Louvre Accord level.
Meanwhile, the yen continued to appreciate, and Japan's monetary policy was further relaxed. Thus, the Black Monday that originated in the United States came to an end, but a new spark of a bubble had certainly spread to Japan at this time.
In this sense, Black Monday, which originated in the United States, and the creation and collapse of the Heisei bubble should be seen as twin crashes.
Can you escape the crash?
So, could investors have avoided Black Monday?
The answer depends on the investor.
It is no exaggeration to say that it would have been nearly impossible for noise traders. The market changes suddenly while investors are trying to figure out each other's tactics. However, since the cause of the market's suspicion was economic fundamentals, smart money (wise investors) would have been able to predict the occurrence of Black Monday to some extent, if not completely.
If that was the case, it would have been entirely possible to adopt a defensive strategy such as reducing the allocation to stock assets (underweighting) in advance. If the trigger for the sudden occurrence of Black Monday was the Fed's actual monetary policy and expectations about its future policy stance, it would have been rational and possible to prepare for Black Monday.
So why did the Japanese bubble burst in 1990 and the IT bubble burst in the United States in 2000? And was it predictable?
The emergence and collapse of these bubbles can basically be explained in much the same way as Black Monday.
In other words, investors are not sure about the future. Investor psychology and unfounded enthusiasm (pessimism) certainly exist. Short-term stock price fluctuations are amplified by these trends and popularity factors. And most investors, mainly noise traders, extend the recent past stock price trends into the future. In this way, once a bubble is born, it expands, and when it bursts, the aftereffects of the bubble deepen. However, stock prices are inherently very sensitive to future long-term dividend growth rates and stock risk premiums. The cause of long-term stock price fluctuations is fundamental. If this is the case, the Heisei bubble and IT bubble are thought to have occurred when some factor caused the expected future growth rate to rise and the stock risk premium to fall. In the case of a sudden fall in the risk premium, excessive interest rate cuts by the central bank could be the cause.
On the other hand, in the case of a significant change in the expected growth rate, the rise of the new economy theory due to IT investment and productivity increases, or the emergence of popular models such as Japan as Number One, could be the cause.
Conversely, the collapse of a bubble occurs when the expected future growth rate falls and the stock risk premium rises. It can be triggered by an interest rate hike in the policy interest rate in response to inflationary pressure, or the decline of a popular model.
What should not be overlooked here is that the mechanism by which changes in the stock risk premium cause future expected growth rates to fluctuate also works at the same time. During the Heisei bubble collapse, the Bank of Japan, which adopted a monetary tightening policy, is concerned that it drastically lowered Japan's expected growth rate in the name of eradicating the asset bubble. There is no doubt that this prolonged and aggravated the bubble collapse.
In the United States, then-Chairman Alan Greenspan also undoubtedly fueled the New Economy theory, claiming that productivity was rising without inflation concerns as stock prices continued to soar in the late 1990s.
By studying the case studies of Black Monday, the Heisei bubble, and the IT bubble in this way, we can understand that economic policies, especially monetary and exchange rate policies, have a huge impact on the creation and collapse of bubbles.
There is certainly an aspect of bubbles expanding in a self-fulfilling manner. However, not all bubbles were created spontaneously in the market and then collapsed. In other words, bubbles are man-made disasters rather than natural disasters.
The stock market certainly failed at this time. However, policy authorities such as the government, the Ministry of Finance, and the central bank could have failed even more.
If that is the case, the crash was not necessarily brought about by a random walk. By focusing on these fundamental factors, smart money can discover the triggers of a crash and should be able to avoid it.
What good news is this!
Will the next Black Monday come from Japan? Or the United States?
Either way, after Black Monday in October 1987, the Heisei bubble was born in Japan, and after 1990, the Heisei bubble collapsed, and the country has been in a long-term economic stagnation for more than 30 years.
However, the Bank of Japan's relentless monetary easing backfired, and in July 2024, against the backdrop of a sharp depreciation of the yen, the Reiwa bubble, which will surpass the Heisei bubble, will boil over, and the Nikkei Stock Average will hit an all-time high of just over 42,000 yen on July 11, the day before the SQ (settlement) day of the July monthly Nikkei 225 futures and options trading (see Appendix: "The Power and Appeal of Nikkei 225 Futures and Options Trading").
Just as the excitement hadn't died down, on August 5th, the Monday of the week of the August Nikkei 225 futures and options SQ (August 9th), a bolt from the blue, a Japan-originated Black Monday, occurred. Are these just coincidences?
In any case, will the Japan-originated Black Monday be a one-off? Rather, will major crashes continue to occur more frequently in the future?
This is because the inconsistencies in monetary policy between Japan and the United States are unlikely to be resolved anytime soon. With no hope of international policy coordination, and especially with the fourfold suffering of a declining birthrate, long-term consumption stagnation, a weak currency, and inflation, we cannot help but fear that Japan, which has just experienced the Japan-originated Black Monday, may face the biggest postwar economic crisis as early as this fall, with an even greater magnitude.
In particular, what surprised me recently was the clear signs of accelerating inflation in the August Consumer Price Index (CPI) for Tokyo's wards, announced on August 30th.
Contrary to popular expectations that inflation in Japan would have slowed down due to the sudden reversal of the yen's appreciation caused by Black Monday this summer, which pushed down import prices, the August Tokyo ward CPI recorded +0.6% (annualized rate +7.2%), +0.5% (annualized rate +6.0%), and +0.4% (annualized rate +4.8%) on a month-on-month basis, respectively, on a comprehensive, core, and core-core basis, clearly showing signs of accelerating inflation.
In particular, in the same statistics, the year-on-year increase in rice prices has rapidly expanded from about +17.7% in July to +26.3% in August (Ministry of Internal Affairs and Communications' Tokyo ward CPI raw data, page 11), and it even seems that the rice riots of Reiwa are finally getting serious.
In addition, it is noteworthy that Japan's PPI (Producer Price Index) for July was up 3.0% year-on-year (up 0.3% month-on-month), far surpassing the US PPI of +2.2% year-on-year (up 0.1% month-on-month) for July.
Needless to say, the PPI is upstream of the CPI, and the former is a leading indicator of the latter, which is a shared asset of economics in both Japan and the US.
By the way, Saburo Shiroyama's masterpiece "Novel Bank of Japan" is famous as a novel based on the Great Reconstruction Inflation, which was mainly caused by the Bank of Japan's purchase of large amounts of financial bonds issued by the Reconstruction Finance Corporation (the forerunner of the current Development Bank of Japan) immediately after the war.
Would it be too much of an exaggeration to say that the "Revival of the Great Inflation," which could be considered the original QE version of the Bank of Japan's quantitative easing immediately after the last war, is now like a ghost, accelerating uncontrollable inflation, including the Reiwa rice riots, and that we cannot help but have a premonition that we are seeing a reappearance of it?
In any case, it is safe to say that the red light of a great inflation acceleration is now flashing. We cannot help but see that an objective economic environment is now emerging in which the Bank of Japan will have no choice but to move toward further interest rate hikes by the end of the year. On the other hand, in the United States, where there are almost no signs of an economic slowdown, simply because de-inflation has been observed, Fed President Powell has clearly been considering starting to cut interest rates after September, which could further inflame the high price level itself, which is the threat of rising living costs, and the US stock prices and home prices, which continue to reach record highs.
The chairman seems almost blind to the existence of Fed President Powell's Achilles heel, that the neutral interest rate is too low. If it is actually desirable for the Fed to raise the neutral interest rate from the current 0.75% to about 2%, which is consistent with the long-term real GDP growth rate, then the probability that the Fed will be forced to not only lower interest rates in the future, but even raise them sooner or later is by no means zero.
If that were to happen, assuming the US nominal GDP level (about $29 trillion) and the US stock market capitalization (about $51 trillion) were given, if a repeat of Black Monday originating in the US were to cause a 20% drop in one business day, the US stock market market capitalization would lose $10.2 trillion (about 1,479 trillion yen).
The shock waves of the loss of wealth, which is more than twice the size of the Japanese economy (nominal GDP is about 600 trillion yen), would have a huge negative impact not only on the US but also on Japan and the whole world, and it would be difficult to deny the fear that a global depression could happen again.
There are two opposing schools of thought on bubbles.
One is the bubble cleanup school, represented by former Fed Chairman Ben Bernanke, which believes that bubbles are difficult to identify, that interest rates have too great an impact on the market, and that regulations and cleaning up after the collapse of the bubble are more effective than interest rates. This is the so-called "left-wing" view.
The other group is the "right wing" group, represented by Professor Taylor (former Assistant Secretary of the Treasury), which claims that it is possible to identify bubbles, even if it is not easy, and that bubbles can be controlled by interest rates. The asymmetry between bold monetary easing and slow interest rate hikes encourages risk taking by economic agents, and may lead to the spread and exacerbation of various moral hazards.
It is unfortunate that both Bank of Japan Governor Ueda and Fed Chairman Powell are clearly not part of the bubble-busting group, and are seen as bubble cleanup groups, which must be said to remain a considerable concern for future Japanese and US monetary policies.
It cannot be said that Black Monday was a one-off, and the only issue may be whether the next Black Monday will originate in Japan, like August 5, 2024, or in the US, like October 1987, and when it will occur.
Summary
Not only is the normalization of Japan's monetary policy far too behind the curve, but the US Federal Reserve has now clearly turned to a lowering interest rate stance, as if it were blind to its Achilles heel, further amplifying the contradictions in monetary policy between Japan and the US. In the future, some cause for concern in the international financial markets could trigger a catastrophe worse than Black Monday in Japan on August 5th.
In any case, with the US asset bubble about to amplify even further, if the US sneezes, Japan will be at risk of becoming seriously ill, not just suffering from pneumonia.
In the final chapter of the classic book "Greenspan: The Man Who Knew Everything," published in 2019 and awarded the FT/McKinsey Business Book of the Year, author Mallaby states the following:
"By focusing monetary policy on inflation, attention to financial dangers was neglected. After Greenspan left the position, the Fed formally adopted inflation targeting, which unfortunately complicated the problem."
He also states that between "fighting bubbles" and "price stability," he prioritized the latter, which seemed easier.
Finally, I would like to conclude by expressing my sincere hope that this monthly newsletter will help Japan overcome its largest simultaneous political, economic, and financial crisis since the war and be a guidepost for the country's recovery.