PRINCES OF THE YEN - Book Synopsis

Japan's Central Bankers and Their Battle to Transform the Nation

With the end of the Cold War it has become clear that military might is superseded by economic power. Principally, governments can only influence the economy, and hence the livelihoods of people, through regulatory, monetary and fiscal policies. However, politicians and their governments have lost control over all three policy tools: deregulation, fiscal tightening and independent central banks mean that economic and political power is increasingly moving from the hands of democratically elected governments into the hands of unelected central bankers. Since they are mere humans, they are also prone to errors and acts of selfishness. In his book Princes of the Yen (Armonk, New York: M.E. Sharpe, $27.95) Werner provides new evidence on the extent of power in the hands of central bankers, and the degree to which they may be willing to use and misuse this power for their own purposes. The evidence comes from Japan.

Princes of the Yen takes a fresh look at Japan's postwar economy and the key factors that shaped it. The author reveals the unexplored role of the central bank and its informal credit controls in the creation of the great asset bubble and the subsequent long recession of the 1990s. He also discusses in detail the role of Toshihiko Fukui, the new governor of the Bank of Japan.

Japan's Puzzles
Japan's post-war economy has remained an enigma to many observers. Having earned the title of 'miracle economy' it sank into a prolonged slump in the 1990s. Experts have had a difficult time to explain the bubble of the 1980s and its collapse in the 1990s. They found it even harder to explain why all government attempts at stimulating the economy failed during the 1990s.

US Occupation Creates Post-War Juggernaut
Showing that pre-war Japan closely resembled today's freewheeling US-style capitalism, Princes of the Yen identifies the real nature of Japan's 'unique' post-war structure. Its system was introduced during WWII. The post-war economic miracle was achieved, because the economy remained fully mobilized and on a war footing. This was possible, because the US Occupation, under pressure from the advance of communism in Asia, decided to keep the wartime system and its personnel in place. While Germany's wartime economic leader languished in a military prison in the 1950s and 1960s, his Japanese colleague was made Prime Minister. Indeed, in the postwar era under the supervision and with the support of the US Occupation the wartime bureaucratic leaders could implement many of those fascist reforms that they had not been able to implement during the war.

Bank of Japan in Key Position
The post-war disappearance of the military triggered a power struggle between the Ministry of Finance and the Bank of Japan for control over the economy. While the Ministry strove to maintain the controlled economic system that created Japan's post-war economic miracle, the central bank plotted to break free from the Ministry by reverting to the free markets of the 1920s.

Despite the Ministry's dominant legal status, the central bank had the better cards: it was in charge of a secret monetary control mechanism - another wartime legacy. The US Occupation had put the central bank insiders into their positions. But they misused them to create a small elite within the central bank that had power over life and death of companies, whole industries, and even the economy. And they had no scruples about using it. They handpicked and groomed their successors early on and called them 'Princes' Hiding behind the smoke screen of traditional interest rate policies, the five Princes that ruled post-war Japan remained unaccountable to anyone - neither the prime minister, nor the ministry of finance nor their own governor.

Princes of the Yen Prolonged the Recession
The Princes wanted nothing less than a revolution. They reckoned that the wartime economic system and the vast legal powers of the Ministry of Finance could only be overthrown if there was a large crisis - one that would be blamed on the ministry. While observers assumed that all policy-makers have been trying their best to kick-start Japan's economy over the past decade, the surprising truth is that one key institution did not try hard at all. To the contrary, the Bank of Japan consistently sabotaged government attempts at creating a recovery during the 1990s. The surprises continue, as we learn that those central bankers who were in charge of the policies that prolonged the recession were the very same people who were responsible for the creation of the bubble. As tape-recorded eyewitness testimonials reveal, the Princes at the Bank of Japan had ordered the banks to expand their lending aggressively during the 1980s. Threat of severe punishment by the central bank left reluctant banks little choice but to comply. In 1989, the Princes suddenly tightened their credit controls, thus bringing down the house of cards that they had built up before.

The key 'Prince' in charge of the tight credit policies of the 1990s that created and prolonged Japan's slump turns out to the none other than Toshihiko Fukui, the new governor appointed in 2003. The 'Princes' in charge of the clandestine credit controls and thus the man creating the bubble of the 1980s turns out to be none other than the same Toshihiko Fukui. We also learn about the astonishing fact that his mentors inside the Bank of Japan already decided a full thirty years ago that he would be the official governor today.

Surprise Recovery Ahead
With banks paralysed by bad debts, the central bank held the key to a recovery: only it could step in and create more credit. It failed to do so, and hence the recession continued for years. Thanks to the long recession, the Ministry of Finance was broken up and lost its powers. The Bank of Japan became independent and its power has now become legal. The Big Bang financial reforms, including the change in accounting standards, are now transforming Japan's economic structure. Finally, the long recession has also changed the political landscape and ushered in a Prime Minister dedicated to deep structural reform. The days of the war economy are numbered. Free markets are being introduced. The recession has almost completely served its purpose. The good news is that Japan's recession has not been due to intractable structural problems. The Princes can engineer a recovery in record time.

Implications for the World - The Power of Central Banks
Werner's book puts the Japanese experience in context of the conduct of monetary policy in Asia, Europe and the US. It then asks the reader to reconsider the role and function of central banks in a democracy. Werner believes there is a need for stronger democratic checks and balances on their activities. No democratically elected politician or government ever gave the Bank of Japan a mandate to prolong the recession or implement structural changes. While Article 1 of the Bank of Japan Law (valid until 31 March 1998) stated clearly that the central bank had to support government policies, the Bank of Japan did the opposite. Its leaders decided that structural changes should be forced through, even at the cost of over five million unemployed and a record-high suicide rate. Instead of an open public debate about the issues, and whether the costs are worth it, the Princes plotted in darkness. Should a central bank be able to do what the Bank of Japan did, and get away with it? Princes of the Yen calls for the institution of a government committee to investigate the implementation of monetary policy, to bring those responsible for its disastrous policies to account. Moreover, it makes detailed suggestions on how the recession can be ended. The Bank of Japan needs to increase credit creation, which it can do by directly purchasing assets from the private sector (such as bonds, CPs, stocks, real estate, etc.). To make the central bank accountable and result-oriented, the book calls for the imposition of a nominal GDP growth target that the central bank must meet, at the threat of losing the top third of its staff. To do this, a revision of the Bank of Japan Law is advisable.