Why the Nikkei Has Fallen 20 Percent in Less Than a Month

The Japanese stock market tumbled 6 percent in the most recent day of trading and has fallen by about 20 percent in three weeks. That comes on the heels of an enormous months-long rally touched off by Prime Minister Shinzo Abe’s agenda of expansionary monetary policy. But it seems that what Abenomics giveth, Abenomics also taketh away.

One longtime Abenomics skeptic wagged at me when the Nikkei closed that this shows you can’t achieve prosperity via currency debasement. But I think Lars Christensen’s chart of inflation expectations reposted above shows the opposite. As long as investors believed that Abe and the Bank of Japan were committed to inflation, investors also believed in shares of Japanese companies. But rising inflation expectations pushed nominal bond yields up (as indeed they would almost have to), which sparked some highly public hand-wringing, a fall in inflation expectations, and a stock market crash. Some will see this as evidence that expectations-based monetary policy doesn’t work (see Cardiff Garcia’s useful roundup of fiscalists versus monetarists), but I tend to think that we’re actually seeing the power of expectations. If BoJ President Kuroda were to issue a strong statement taking note of the situation and reiterating his intention to push inflation expectations back up to 2 percent despite being fully aware that this will increase nominal yields on Japanese bonds, then I bet that we’d see all these trends reverse.

But whatever you make of that, let there be no mistake—the Nikkei rally corresponded with a decline in the yen and a rise in inflation expectations while the crash has corresponded with a stronger yen and lower inflation expectations. The variable all move together. The scenario in which the currency is debased and the real economy suffers has not yet been seen.

Meanwhile in light of the continued debate on this topic, let me once again urge legislators in major developed countries to pass laws designed to explicitly authorize joint fiscal-monetary operations (i.e., “helicopter drops”) in which, rather than purchasing bonds, central banks will directly give cash to citizens. The bond purchasing channel is problematic in a number of ways, not least of which is that it invites precisely the confusion over the direction of interest rates that seems to have tripped Japan up. When large-scale asset purchases push asset prices down rather than up, people become confused. Direct cash injections explicitly designed to boost prices and real output are clearer, fairer, and more transparent.