July 13, 2003

The Hand that Sets the Interest Rates Rules the World, Werner Says

by Declan Hayes, Professor of Finance, Sophia University, Tokyo

In the course of giving us a detailed history of the Bank of Japan over the last 100 years, Princes of the Yen makes a number of controversial points. Chief among these is that the inner circle of bureaucrats who have controlled the central bank since U.S. Gen. Douglas MacArthur's days deliberately created the bubble economy of the 1990s to help restructure Japan and to destroy the nation's much maligned Finance Ministry.

Richard Werner compares these Bank of Japan gentlemen, these secretive "princes of the yen," to the equally secretive and manipulative Kwantung Army of the early Showa era.

Werner, an assistant professor of economics at Sophia University who writes about business issues for the Commentary page of this newspaper, believes these princes have had an inordinate influence in Japan and that they should be put under parliamentary control in the interests both of democracy and of the Japanese economy.

No wonder this book was a best-seller when originally published in Japanese. We all love intrigue, especially when it implicates our superiors in nefarious deeds. And that's what Werner does in this excellent book.

In throwing his well-honed barbs at some of Japan's most powerful economic figures, he claims that Japan's monetary policies were borrowed from Germany's Weimer Republic, and that they were geared toward war to maximize output above all else. The resulting tools of credit creation and credit denial allowed Japan's leaders to induce companies like Yamaha to make pianos before the war, machine guns during the war and the famous Yamaha motorbikes after the war. In a system like Japan's, in which banks rather than stock markets are at the center of economic life, the institution that controls the banks' credit creation policies controls the economy.

Werner gives an excellent account of how Japan's credit creation system allowed such a centralized system of government control and indicative planning to work and succeed to a degree not seen in any other peacetime economy. Werner contends that since the war, the Bank of Japan has controlled Japanese monetary policy through clandestine control of the quantity of credit available in the economy. This control, he argues, has allowed it to dictate the pace of economic activity in Japan.

Werner is on very strong ground when he discusses the historical evolution of Japanese monetary policy. He has an excellent and far-reaching grasp of both Japanese economic history and the theory and practice of monetary economics. Japan has been a country operating what Werner calls a war economy but what other economists would instantly recognize as a neomercantilist economy. Production maximization, mass exports and social control have been Japan's keys to success.

And, according to Werner, the princes of the yen--the Bank of Japan's top officials, not the much maligned Finance Ministry--have held those keys and have used them whenever and however they have seen fit. He names many of these princes and, in chapter 13, he explicitly credits two of them with deliberately causing the bubble economy.

In subsequent chapters, Werner answers the question he poses at the end of chapter 13: "Why on earth did they do what they did?" Werner believes the Bank of Japan's leaders wanted to achieve two main interrelated goals: They wanted to destroy the Finance Ministry, and they wanted to deregulate the Japanese economy. To achieve those ends, he argues that the bank used its control over the economy to engineer today's decadelong recession in the pursuit of what amounts to a political goal, namely to scrap Japanese-style welfare capitalism and replace it with the deregulated markets that typify U.S.-style shareholder capitalism. Because the Finance Ministry was blamed for the recession, it, rather than the Bank of Japan, lost credibility and was declawed a few years ago, thus leaving the central bank in total control of formulating Japanese monetary policy.

As well as detailing the fate of the Finance Ministry, Werner cites recent structural changes as well as the recent spate of foreign takeovers of Japanese firms in support of his thesis that the Bank of Japan engineered the recession to induce the structural reforms that are now rippling through corporate Japan. Although The Bank of Japan and its supporters inevitably will disagree with his analysis, there is a lot to argue about and to discuss in this pathbreaking and thought-provoking book.