Free Exchange

Can central bankers talk too much?

As the Fed and the ECB have learnt, transparency has its downsides




IMAGINE YOU are a journalist trying to reassure your bosses that you will hit a tight deadline. What would be more effective: a forceful but brief commitment that you will do whatever is needed to get the job done, which leaves them in the dark on all the things that might go wrong along the way? Or a plan detailing every step you will take—but in which they can spot unnerving risks?

That resembles the choice central banks face as they try to convince financial markets and the public that they will meet their goals. Over the past decade their preference has been clear: the more transparency and detail, the better. In 2011 America’s Federal Reserve began holding press conferences after its monetary-policy meetings.

It started publishing the range of rate-setters’ economic forecasts the following year. Across the rich world, forward guidance on the path of interest rates has become part of the toolkit.

Central bankers make ever more speeches, bringing once-hidden debates out into the open.

Some tweet their views.

The theoretical justification for all the talk is strong. The more markets understand how the central bank will react to events, the better they anticipate future policy. Conditions in financial markets should immediately tighten or loosen in response to economic news, making central bankers’ jobs easier. It is as if setting out your plan to your boss makes it easier to implement.

Today, however, the theory is being tested. The European Central Bank (ECB) meets on October 24th, after The Economist goes to press, amid a very public row about monetary policy. In September the ECB said that it would restart quantitative easing (QE), the purchase of bonds with newly created money, and that it would keep buying assets until inflation picks up from its current level of 1% towards the bank’s aim of close to 2%.

Hawks such as Klaas Knot, the head of the Dutch central bank, have been unusually vocal in their dissent. Bond yields, which move inversely to prices, first fell as markets digested the ECB’s guidance. But the bickering has since sent them in the other direction. Market pricing now also reflects expectations of how the political struggle over open-ended QE will play out. Investors have spotted a flaw in the plan.

In America the Federal Reserve may cut interest rates for a third time this year on October 30th. It has been accused by economists at Goldman Sachs, a bank, of constructing a “hall of mirrors” in its communications with markets. The Fed, the argument goes, has this year simultaneously signalled its intentions to bond markets while taking its cues from them. But bond yields are a prediction of what the Fed will do, not an instruction.

As a result, the Fed and the markets have entered a pessimistic spiral, while the real economy has been ignored. In its eagerness to be in touch with markets, the Fed has forgotten that it is in the lead.

Central banks everywhere must also work out how to offer forward guidance when facing sharply divergent forks in the road. A trade truce between America and China could transform the economic outlook. A no-deal Brexit could cause chaos in Britain that spills over to the rest of Europe. Telling markets what to expect of policy is much harder when prediction involves choosing between black and white.

Might it help, therefore, for central banks to talk a little less? Microeconomists have long known that ambiguity can have strategic uses. Employment contracts, for example, do not specify every action an employee must take, nor all the obligations of an employer, possibly because it may be better to leave room for either side to punish the other’s bad behaviour.

In recent years Bengt Holmström of MIT, who in 2016 won the Nobel prize for economics, has argued that central-bank opacity has its uses in credit markets. Most of the time, he argues, these markets, unlike stockmarkets, are “information-insensitive”—they do not respond much to news. In contrast to stocks, there is no upside for the lender when things go especially well, and default is a remote risk, especially when loans are adequately collateralised. “A state of ‘no questions asked’ is the hallmark of money-market liquidity,” he argues.

In a panic, however, money-markets dry up as the risks loom larger. Lenders find themselves having to scrutinise every transaction. Restoring stability might require a promise that is light on detail, and thus hard to pick apart.

At the worst of the euro zone’s sovereign-debt crisis, for instance, Mario Draghi, the head of the ECB, pledged to do “whatever it takes” to keep the single currency safe. Mr Holmström also notes that when the Fed provided emergency lending to banks during the financial crisis, it did not disclose which institutions received support, for fear that any associated stigma could provoke bank runs.

Too much information

Might a similar logic carry across to central bankers’ everyday goals, such as targeting inflation? Inflation expectations, like financial panics, can prove self-fulfilling. Some economists reckon that central banks’ promises to keep inflation low may have become so credible that the public rarely revises its expectations in light of economic news—another case of “no questions asked”.

But the analogy breaks down when it comes to interest rates. Rates vary and markets have to expect something. Central banks might as well steer such expectations. The limits of communication are best seen as the latest round in the decades-old battle between those who want monetary policy to be set by rules, and those favouring discretion. The clearest forward guidance would be a fully transparent algorithm that relates interest rates to economic data. But such a mechanical “reaction function” exists only in economic models. In reality, policymakers have to use their judgment, meaning their decisions are inherently uncertain.

As long as that is true, there is a limit to how much more transparency can make interest rates predictable. And, as the recent experience of central banks shows, talking can have its downsides.

It is worth pondering when silence might be Golden.

Investors start to ponder ‘QE infinity’ from the ECB

Amid weak growth and inflation, fund managers contemplate the limits of bond-buying

Tommy Stubbington



As the European Central Bank limbers up to restart its debt-buying programme, one question looms large for investors: how long can the purchases continue before the bank runs out of bonds to buy?

The ECB is due to start acquiring €20bn of bonds a month in November, just a few days after this Thursday’s policy meeting — Mario Draghi’s last as president, before handing over to Christine Lagarde. Analysts estimate that the quantitative easing programme can run until the end of next year before bumping up against the central bank’s self-imposed limits, under which it can own no more than a third of any eurozone country’s bond market.

But things could quickly get tricky for Mr Draghi’s successor. If the current downturn intensifies and the central bank wants to increase its stimulus, the thorny question of raising this limit would have to be tackled much sooner.

For investors who have bet heavily on a bond-buying programme that stretches as far as the eye can see, any doubts about the future of QE are uncomfortable.

“This is the fundamental question that will frame the first months of Lagarde’s tenure,” said Richard Barwell, head of macro research at BNP Paribas Asset Management. “Are there quasi-legal constraints that will stop them buying, or is this QE infinity?”

Mr Draghi’s plans, unveiled last month, initially seemed to satisfy stimulus-hungry investors — despite their relatively small size — thanks to an open-ended promise to keep buying until inflation moves back to the central bank’s target.

A graphic with no description


Since then, however, the summer’s almighty bond rally has gone into reverse amid a growing backlash against the QE package from current and former members of the ECB’s governing council. In a blow to bond bulls, minutes from the September meeting showed that policymakers did not even discuss raising the 33 per cent limit, citing concerns that to do so would blur the boundary between monetary and fiscal policy.

But after buying €2.6tn of debt in its previous QE rounds, the ECB is already close to the 33 per cent threshold in some countries. Gauging exactly how close is complicated. The value of the ECB’s holdings needs to be translated from market value back to its nominal value. Moreover, the total universe of eligible debt is not easy to define, given it contains bonds issued by supranational agencies as well as governments.

Frederik Ducrozet, senior European economist at Pictet Wealth Management, estimates that the ECB is closest to the limit in the Netherlands and Germany, where it owns 31 per cent and 30 per cent respectively. In Italy and France the equivalent figure is just 21 per cent.

The levels are uneven because of another ECB rule: it has to buy amounts in proportion to each country’s contribution to the ECB’s capital. That means it holds a bigger slice of the pie in less-indebted economies.

A graphic with no description


In practice, however, the central bank has had to bend this rule since the start of the QE programme in 2015 because some countries, such as Estonia, had almost no bonds to buy, while low-rated Greek debt was not eligible for the programme.

By bending the rules further, or focusing more of its buying on corporate bonds, Mr Ducrozet thinks the current programme could last until the end of 2020.

“But there’s a political limit to how far they can go,” Mr Ducrozet said, noting that if the ECB were to divert purchases elsewhere, it could face accusations it is favouring certain eurozone states over others.

Extra borrowing from Berlin would help ease the bottleneck by creating more Bunds, but few are expecting a meaningful fiscal splurge from Germany. Eurozone governments are projected to issue a net €161bn of debt in 2020, according to Silvia Dall’Angelo, a senior economist at Hermes Investment Management, meaning the ECB will swallow up all the new bond issuance and more.

Raising the 33 per cent limit, which was designed to prevent the ECB from holding enough of one country’s debt to block a restructuring, could be even more controversial. It would also breathe new life into objections that the ECB is in effect financing profligate governments via the back door with its QE.

For fund managers weighing up whether such objections can be overcome, the change in leadership at the ECB adds an extra layer of complexity.

“If we were operating with another eight years of Draghi, who has nearly always got his way, I think we know how this would play out,” said Mr Barwell. “The complicating factor is it’s not him.”

Even so, Ms Lagarde may be able to pick up where the Italian left off, particularly if the threat of recession helps her convince colleagues that more stimulus is needed.

Recent economic data in the eurozone have made for grim reading while long-term inflation expectations are close to a record low. If the spectre of deflation returns, the ECB would be more inclined to tear up its own rule book, according to Ms Dall’Angelo.

“Remember that at one point everyone thought QE in the eurozone couldn’t happen,” she said.

“But the last few years have taught us that if the situation is serious enough, nothing is impossible.”

The future of the EU

Emmanuel Macron warns Europe: NATO is becoming brain-dead

America is turning its back on the European project. Time to wake up, the French president tells The Economist




EMMANUEL MACRON, the French president, has warned European countries that they can no longer rely on America to defend NATO allies. “What we are currently experiencing is the brain death of NATO,” Mr Macron declares in a blunt interview with The Economist. Europe stands on “the edge of a precipice”, he says, and needs to start thinking of itself strategically as a geopolitical power; otherwise we will “no longer be in control of our destiny.”

During the hour-long interview, conducted in his gilt-decorated office at the Elysée Palace in Paris on October 21st, the president argues that it is high time for Europe to “wake up”. He was asked whether he believed in the effectiveness of Article Five, the idea that if one NATO member is attacked all would come to its aid, which many analysts think underpins the alliance's deterrent effect. “I don't know,” he replies, “but what will Article Five mean tomorrow?”

NATO, Mr Macron says, “only works if the guarantor of last resort functions as such. I’d argue that we should reassess the reality of what NATO is in the light of the commitment of the United States.” And America, in his view, shows signs of “turning its back on us,” as it demonstrated starkly with its unexpected troop withdrawal from north-eastern Syria last month, forsaking its Kurdish allies.

In President Donald Trump, Europe is now dealing for the first time with an American president who “doesn’t share our idea of the European project”, Mr Macron says. This is happening when Europe is confronted by the rise of China and the authoritarian turn of regimes in Russia and Turkey. Moreover, Europe is being weakened from within by Brexit and political instability.

This toxic mix was “unthinkable five years ago,” Mr Macron argues. “If we don’t wake up [...] there’s a considerable risk that in the long run we will disappear geopolitically, or at least that we will no longer be in control of our destiny. I believe that very deeply.”

Mr Macron’s energetic recent diplomatic activity has drawn a great deal of interest abroad, and almost as much criticism. He has been accused of acting unilaterally (by blocking EU enlargement in the Western Balkans), and over-reaching (by trying to engineer direct talks between America and Iran). During the interview, however, the president is in a defiant but relaxed mood, sitting in shirt sleeves on the black leather sofa he has installed in the ornate salon doré, where Charles de Gaulle used to work.

The French president pushes back against his critics, for instance arguing that it is “absurd” to open up the EU to new members before reforming accession procedures, although he adds that he is ready to reconsider if such conditions are met.

Mr Macron’s underlying message is that Europe needs to start thinking and acting not only as an economic grouping, whose chief project is market expansion, but as a strategic power. That should start with regaining “military sovereignty”, and re-opening a dialogue with Russia despite suspicion from Poland and other countries that were once under Soviet domination. Failing to do so, Mr Macron says, would be a “huge mistake”.

viernes, noviembre 08, 2019

GOLD - THE DECISION IS CLOSE / SEEKING ALPHA

|


Gold - The Decision Is Close

by: Florian Grummes



Summary
 

- Sideways period might have been the calm before the storm.

- Weekly and daily charts are slightly bullish.

- Commitment of Traders Report remains very negative.

- Sentiment has cooled down in recent weeks.

- Seasonality is very promising until end of February.

 
Since 3rd of September, gold and the SPDR Gold Trust ETF (NYSEARCA:GLD) have been consolidating for nearly two months and now seem to be getting ready for the next move higher!
 
With the breakout of the triangle a first bullish indication is on the table.
 
After next week's FED decision gold should provide a clearer picture.
 
If gold can move above US$1,520 the next leg up has a potential price target of US$1,800 by January or February 2020.
 
Review
 
Since the 3rd of September, gold and the SPDR Gold Trust ETF (NYSEARCA:GLD) have been in a corrective phase, which has so far mainly led to a shift away from a clearly trending and directional market towards a confusing and difficult sideways market.

Even though the gold price corrected from US$1,557 down to US$1,460, compared to the previous advance this correction has been rather mild so far.
 
And after an initial sharp rebound to nearly US$1,520, gold has been trading sideways between US$1,480 to US$1,500 over the last three weeks.

The daily trading range had become significantly smaller and accordingly volatility has been on a decline.

With prices moving sideways, a clear trend has been missing.

Presumably, this might have been only the calm before the storm.

As of Thursday, gold started to break out of its triangle and moved above US$1,500.

Friday's rally towards US$1,517 however was not sustainable and gold closed right at the edge of the triangle.

Technical Analysis: Gold in US Dollars

Gold in US-Dollar, weekly chart as of October 27th, 2019. Source: Tradingview


On the weekly chart, since August 2018 gold is moving within a major uptrend channel. This channel currently offers space up to around US$1,585.

On the downside, below US$1,460 prices would slip into the lower half of the trend channel.

The July consolidation took place just around the middle trend-line of this channel.

Actually, this trend-line should hold for the next few months and catapult gold prices higher.
 
Due to the pullback in recent weeks, the overbought position in the Stochastic Oscillator has been neutralized.

A clear new buy signal is not yet available and theoretically, the oscillator still has plenty of room to the downside.

A counter-cyclical opportunity is therefore certainly not present in the gold market.

However, the current setup allows for a new multi months rally.

The potential cup & handle formation I present the last time is still possible and could bring spectacular gains in the next few months.
 
In conclusion, the weekly chart is still "slightly bullish".

The next price target is US$1,585.
 
Gold in US-Dollar, daily chart as of October 27th, 2019. Source: Tradingview
 
 
On the daily chart, a symmetrical triangle has developed over the last few weeks.
 
The shrinking trade range is a typical behavior as the prices move into the apex of the triangle.
 
At the same time, the Bollinger Bands continue to contract, while the stochastic oscillator also consolidates sideways in a triangle.
 
Friday's breakout presented the explosive move out of the formation.
 
The established uptrend coupled with various other bullish factors made a breakout to the upside more likely.
 
As this breakout happened late in the triangle apex though, the move does not have to be very strong.
 
And in light of the upcoming FED meeting on Wednesday, gold could still dip one more time back below US$1,500 before starting its next wave higher towards US$1,585.
If, on the other hand, bears prevail and can push gold prices below $US1,480, the middle line of the uptrend channel (around US$1,460) should come into focus rather quickly.
 
Also, a further drop towards the rising 200-day line (US$ 1,378) becomes very likely in this case.
 
Even though Friday's price action has been a bit doubtful, the daily chart is slightly bullish too.
 
If the bulls can push prices one more time above US$1,510 and then even above US$1,520 gold is back in bull mode.
 
Below US$1,480, and especially below US$1,460 however, bears will take over.
 
Commitment of Traders: Gold
 
Commitment of Traders for Gold as of October 26th, 2019. Source: CoT Price Charts
 
 
So far, the Commitment of Trades structure has only slightly improved during gold's recent correction.
 
The commercial hedgers reduced their cumulative net short position by just under 16.5% from 345,145 down to "only" 288,275 gold futures contracts.
 
Overall, however, this short position is still dangerously high in the longer-term comparison and sits clearly above the healthy average.
 
Sooner or later the professionals will want to make a profit here for which they will need much lower gold prices.
 
On the other hand, the large speculators (primarily trend-following hedge funds) took only small profits despite the massive rally since end of May.
 
Only if the commercial hedgers succeed in arranging a large sell-off in the gold market will the large speculators be forced to sell their positions due to triggered stop-loss orders or margin calls.
 
So far this has not (yet) been the case.
 
Especially the string physical demand from the various gold ETFs has held up the market well.
 
We can assume that the gold prices would only start to slide at prices below the last low at US$1,460.
 
Commitment of Traders for Gold as of October 26th, 2019. Source: Sentimentrader
 
 
Alternatively, the commercial traders have to sit out their short positions for a longer period of time.
 
Because of their deep pockets, however, they can do so without any problem for many months.
 
Overall, the CoT report continues to deliver a clear sell-signal. Admittedly, the CoT report is not a good timing tool to detect short-term reversals. Often buy or sell signals based on the CoT report can last for quite some time before the market actually starts to move in the appropriate direction.

Sentiment: Gold

Sentiment Optix for Gold as of October 26th, 2019. Source: Sentimentrader
 
 
The current sentiment data provide a more balanced or almost neutral sentiment for the gold market.
 
For example, Sentimentrader's sentiment index ranks in the middle of the mood scale with 60 out of 100 possible points.
 
In summary, the sentiment analysis currently comes to a neutral conclusion. By contrast and in the big picture, the precious metals sector is far away from any euphoria similar to 2010 and 2011.
 
Seasonality: Gold
 
Seasonality for Gold as of October 26th, 2019. Source: Sentimentrader
 
Looking at the seasonal cycle, gold is now entering its second best phase of the year! This bullish cycle usually begins in early or mid of October and lasts towards mid or end of February.
 
Based on the statistics of the last forty years, Seasonality provides a green signal for the next four months and should be more supportive for gold. However, in February or latest March 2020 the seasonal pattern does roll over as gold usually starts a correction in early spring.
 
Bitcoin/Gold-Ratio
 
Bitcoin in Gold as of October 26th, 2019. Source: XE
 
 
With Wednesday's mini-crash in bitcoin below US$7,500, the ratio between gold and bitcoin shifted further in favor of gold. With Bitcoins short-squeeze on Friday however the ratio shot dramatically higher. Now 1 bitcoin costs 6.14 ounces of gold. In other words, you currently have to pay around 0.163 bitcoin for one ounce of gold.
 
Since our recommendation in late June/early July to overweight gold against bitcoin, the situation has now reversed. Below US$8,200, Bitcoin is now in the accumulation phase. And as the downside risk in Bitcoin is rather shallow (worst case possibly still down to US$ 6,200), a gradual and step-by-step overweighting of bitcoin against gold seems to make sense now.
 
Generally, buying and selling Bitcoin against gold only makes sense to the extent that one balances the allocation in the two asset classes! At least 10% and a maximum of 25% of one's total assets should be invested in precious metals (mostly physically), while in cryptos and especially in Bitcoin one should hold at least 1% and a maximum of 5%. If you are very familiar with cryptocurrencies and Bitcoin, you can individually allocate higher percentages to Bitcoin.
 
For the average investor, who is also invested in equities and real estate, 5% in the highly speculative and highly volatile Bitcoin is already a lot!
 
Conclusion and Recommendation
 
Over the last three weeks, the price of gold has hardly moved! Until the FED´s interest rate decision this Wednesday expect a confusing and unclear picture. But this should only build even more pressure for the next big move as the narrow trading range will certainly not last forever.
 
The direction of the next sharp movement initially is unclear, however, the bulls have the better cards. This is mainly due to the established multi-months uptrend and the slightly bullish daily and weekly charts. As well you can argue that after a 14 months rally in the gold market we are still missing the final parabolic explosion that usually brings the end to such a complex up wave.
 
The first wave saw gold rallying from US$1,160 to US$1,346. The second wave up ran from US$1,265 to US$1,557. The third and most dynamic wave in this cycle is yet to come and could bring the "grande final" with a fast and furious parabolic move to US$1,800.
 
This is not to say that gold's bull market will end with such an overshot but it should bring the necessary multi-months correction starting in spring 2020 with a pullback towards US$1,500 and later US$1,350.
 
Short-term, a clear indication that the rally is going to continue will now be a move above US$1,520. At the same time, prices below US$1,480 would be increasingly bearish. Below US$1,460, gold will likely slide towards US$1,400 and even lower.
 

Electing America’s Economic Future

Next year's US presidential election will have far-reaching consequences, not least for the economy. Given the stakes of the outcome, rigorous analysis of the candidates' sharply diverging – and often risky – policy platforms is urgently needed.

Michael J. Boskin

boskin66_GettyImages_dollarsignballotbox


STANFORD – A year from now, the United States will elect its next president. The stakes are high, and the outcome will reverberate across the world in a number of spheres, not least the economy.

Yet, thus far, most discussions of candidates’ economic policy proposals have been based more on feelings or ideology than rigorous analysis.

Barring a major unforeseen catastrophe, US economic performance will play a decisive role in the election. If the economy remains strong – unemployment is at a 50-year low for all workers, and its lowest-ever level for African-Americans and Hispanics – President Donald Trump stands a good chance of winning a second term.

Yet downside risks are mounting. If they materialize, a Trump victory would become less likely. According to recent models by Moody’s Analytics, it would take a tanking economy – or unusually high voter turnout among Democrats, but not Republicans – for Trump to lose in 2020.

As center-left former Vice President Joe Biden, the early frontrunner for the Democratic Party nomination, loses ground to the far-left US Senator from Massachusetts, Elizabeth Warren, Trump’s chances of success may be rising. Then again, in the 1980 election, the most conservative Republican candidate, Ronald Reagan (whom I advised), was also labeled unelectable.

If Trump does win a second term, he cannot always be expected to pursue traditionally conservative economic policies, such as his 2017 Tax Cuts and Jobs Act, which brought the US corporate-tax rate in line with the OECD average. Judging by hints from him and his advisers, however, he can be expected to pursue another round of regulatory and tax reform.

Meanwhile, Democratic presidential candidates favor expanding the social safety net, beginning with health care. While some want to build on President Barack Obama’s 2010 Affordable Care Act – which Trump and congressional Republicans failed to “repeal and replace” – others hope to eliminate private insurance, on which two-thirds of Americans depend.

In place of private health insurance, Democrats like Warren and Vermont Senator Bernie Sanders plan to introduce a government single-payer system. The costs would be staggering – over $30 trillion in the first decade, by some estimates. Sanders would raise taxes; Warren is trying to dodge saying so. Given the price tag, that would have to mean massive income or payroll tax hikes, or a Europe-style regressive value-added tax, any of which would fall heavily on the middle class and weaken economic incentives.

But that is not all: Democrats also plan to introduce expensive subsidies, tax breaks, direct spending, loan forgiveness, and other giveaways, insisting that these proposals can be funded largely by increasing taxes on the wealthiest Americans. Biden wants to double the capital gains tax; Warren would almost double the top marginal income-tax rate from 37% to 70%, and both she and Sanders favor new wealth taxes, which even most Nordic countries have abolished. But their math does not add up, by at least an order of magnitude.

There is one area where Trump and the Democrats both want to spend more: infrastructure. Repairing and maintaining roads, ports, and airports is partly the federal government’s responsibility, but state, local, and private finance should be expanded. Neither Trump nor any of the Democratic candidates seeking to challenge him has put forward a serious plan. With neither party focused on fiscal responsibility, the growing unfunded liabilities in Social Security and Medicare, several times the national debt, mean Americans will face far more damaging tax hikes or draconian spending cuts in the future.

Trump and his Democratic opponents diverge much more sharply on government regulation. Trump has made rolling back excessive Obama-era regulations a high priority. While courts have blocked some of his efforts, as they did to Obama, he has successfully weakened or repealed a number of measures on energy and the environment, health care, and finance that Republicans deemed too costly.

The Democratic candidates, especially Warren, hope to do just the opposite. Some favor stronger regulation and antitrust enforcement concerning Big Tech, while Sanders and Warren advocate breaking up the sector’s largest companies. All support the $10 trillion Green New Deal, an economically, scientifically, and numerically illiterate program, or even more radical plans. A Democratic president could also be expected to tighten financial regulation, and potentially even introduce radical changes to corporate law.

On trade, Trump has placed a high priority on changing dynamics that he considers unfair. It is on these grounds that he negotiated a modest revision to the North American Free Trade Agreement (NAFTA), which awaits congressional approval, and introduced escalating tariffs on China.

But the trade war against China that Trump launched last year has become a drag on business investment, dampening the positive effects of his tax and regulatory reforms. Fortunately, the US and China recently reached a temporary agreement forestalling further tariff hikes while a more comprehensive deal is negotiated. Although the Democrats have often criticized Trump’s approach, they are not proposing further trade liberalization.

A final question to consider when assessing the US presidential candidates is whom each would appoint as the next chair of the US Federal Reserve. Trump – who has repeatedly criticized current chair Jerome Powell for pursuing too little monetary-policy easing – would probably select a dovish candidate.

A left-leaning Democrat might do the same, given the left’s fascination with risky ideas that promote massive amounts of Fed-funded debt. Center-leftists – Biden, Amy Klobuchar, Pete Buttigieg – might reappoint Powell, who has done a good job, or select a moderate Democratic economist, such as former Fed Vice Chair Alan Blinder or former Treasury Secretary Larry Summers.

With so many candidates still on the field, investors and financial markets seem to be awaiting stronger signals about the political future and the considerable, but different, economic and financial risks that a victory by each would entail.


Michael J. Boskin is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution. He was Chairman of George H. W. Bush’s Council of Economic Advisers from 1989 to 1993, and headed the so-called Boskin Commission, a congressional advisory body that highlighted errors in official US inflation estimates.


For Japan, the Sword Is the Shield

Is Tokyo’s remilitarization nearing an inflection point?

By Phillip Orchard



World War II determined that the United States, not Japan, would be the dominant military force in the Western Pacific. After all, you can’t be a dominant military force without a military – and the U.S. saw to it that Japan wouldn’t when it made Tokyo constitutionally renounce all martial enterprises.

But things changed, as they so often do. Washington quickly concluded that the demands of the Cold War were such that it couldn’t afford to give Japan a free ride on U.S. defense guarantees. So the United States – the same United States that drove Tokyo to embrace pacifism in the first place – pushed Japan to rebuild a robust but solely defensive-oriented force.

Their alliance became known as “the spear and the shield.” Japan was the shield, invaluable as it was in containing Soviet naval adventures in Northeast Asia, and the U.S. was the spear, projecting power for offensive purposes whenever the situation demanded.

More recently, slowly but surely, Tokyo has built up new military capabilities and has begun removing the political and legal obstacles that prevent it from using them. Now the U.S. wants Japan to do even more – and fast. On Sunday, an unnamed senior Pentagon official in Tokyo issued a rare call for Japan to kick its remilitarization efforts into overdrive, saying Japan’s aversion to offensive weaponry was “no longer acceptable,” and that other restrictions are “affecting the ability of both U.S. forces and Japan’s own Self-Defense Forces to prepare for contingencies.”

This came two days after Tokyo confirmed that it was planning to deploy warships to the Middle East to protect vital shipments of oil and natural gas. Such plans have been in the works since a Japanese-operated oil tanker was attacked in June in the Gulf of Oman, an incident that was followed by a suggestion from U.S. President Donald Trump that the U.S. military was losing interest in protecting other countries’ commercial traffic.

Notably, though, Japanese Chief Cabinet Secretary Yoshihide Suga made it clear that Japan would not formally join the U.S.-led maritime coalition to protect commercial vessels around the Arabian Peninsula – and that Japanese warships would not patrol the contentious Strait of Hormuz, the critical chokepoint where an outbreak of conflict with Iran would be most likely.

The question these two developments pose is: Is Japanese remilitarization nearing an inflection point?


 

(click to enlarge)

 

     
Washington’s concern over a fully remilitarized Japan made enough sense in the past. Historically, in fact, a primary U.S. goal in forming alliances has been to contain the power of its partners, rather than to benefit from their assistance. And since the end of the Cold War, preventing the rise of regional hegemons has been a core tenet of U.S. strategy across the globe. A resurgent Japan capable of militarily acting independently of the U.S. would risk upsetting stability in the Western Pacific by accelerating the arms race among the region’s myriad rival powers, while undermining the U.S. unquestioned dominance of the seas and its cherished alliance structure. (See: the Japan-South Korea feud that just won’t die.)

Over the past decade, though, it’s become clear that the biggest threat to the regional balance of power is not Japanese remilitarization but Chinese militarization – to say nothing of China’s “salami slicing” tactics along critical sea lanes in the East and South China seas – as well as North Korea’s plunge into nuclear statehood and the fact that the U.S. is simply too overstretched to continue to be the world’s policeman. In this environment, the U.S. needs Japan to do more to keep the region in balance – even if its remilitarization will inevitably unnerve other U.S. allies like South Korea, while making it easier for historical adversaries like North Korea, China and Russia to justify their own assertiveness.

Tokyo is keen to step up. Given its overwhelming dependence on resource imports and manufacturing exports, it has little choice but to build the capabilities to protect sea lanes farther afield, including those in the Middle East. Japan has therefore been trying to persuade Washington for nearly a decade that U.S. interests would be well served by a more assertive Japanese military posture – and that major changes in both the international system and Japanese society guarantee that its remilitarization won’t lead to some sort of a revival of Japanese imperialism. The U.S. has been tacitly supportive of this shift; you don’t sell a country a bunch of F-35Bs (the variant of the warplane capable of taking off from flat-decked warships like Japan’s new Izumo-class destroyers, which will soon be converted into small aircraft carriers) if you don’t want it to project power beyond its territorial waters. The latest, more explicit call from the Pentagon for Tokyo to embrace offensive warfare merely suggests that the two sides are now working together to make it happen.

 


 

With the U.S. increasingly on board, the remaining constraints on Japanese remilitarization are internal political, legal and budgetary factors. This is illustrated by the Abe government’s quixotic quest to amend or reinterpret the war-renouncing Article 9 of the Japanese constitution. It’s also illustrated by Japan’s cautious approach to keeping vital sea lanes open in the Middle East.

Article 9 hasn’t kept Tokyo from building out its military capabilities or from blurring the legal lines on their use. Japanese anti-mining capabilities are considered elite, for example, making it an ideal partner in the effort to keep maritime traffic flowing around the Arabian Peninsula. In 2014, moreover, the government approved a reinterpretation of Article 9 to permit the military to exercise the right of collective self-defense – essentially allowing Japanese forces to come to the aid of allies under attack during operations deemed necessary for Japanese security. Two security laws implemented in 2016 formalized the reinterpretation and expanded the scope of the type of operations that the Japanese military can support. Since then, Abe’s government has been gradually lifting informal caps on military spending, activating the first Japanese marine unit since World War II, while pursuing weapons systems – such as the aforementioned carriers and long-range cruise missiles capable of striking ballistic missile launch sites in North Korea – that underscore the idea that the best defense is a good offense.

Still, the legal and political constraints embodied by Article 9 have certainly limited the military’s ability to contribute to maritime stability beyond Japanese waters or prepare for a future crisis on its doorstep. In a real crisis, the Japanese public would probably support whatever measures Tokyo deemed necessary to secure the country. But Japan can’t wait until a crisis erupts to shift course. Its ability to respond will depend on peacetime decisions made years in advance over issues such as spending, training and doctrine. And preventing a crisis from erupting in the first place means taking part in multinational stabilization coalitions like the one developing in the Middle East. Japan is willing to join, but the unsettled legal and political constraints on the Japanese Maritime Self-Defense Force have left it with tightly restrictive terms of engagement, forcing it to steer well clear of the areas where risks of conflict are highest (and where its contributions would be most valuable).

No country likes to be told what to do, and Abe’s government can ill-afford to be seen as flouting or changing Japanese law at the bidding of an outside power. But fact of the matter is that there remains strong opposition to remilitarization. Tokyo’s timeline for revising Article 9 keeps getting pushed back, despite Prime Minister Shinzo Abe’s ruling Liberal Democratic Party’s holding a supermajority in both branches of the Japanese legislature. Abe may therefore welcome the public push from the Pentagon to gun up, just as he likely welcomed Trump’s call this summer for Japan to take responsibility for securing oil shipments through the Persian Gulf. The more the Japanese public grows concerned about threats from China and North Korea, and the more it feels uncertain about U.S. willingness to protect it from those threats, the more likely it will be to back Abe’s revision push.

Whether or not Abe succeeds in revising the charter this year, Japan’s long-term trajectory is clear. The country has little choice but to take greater responsibility for its far-flung interests. And Japan has the technological and industrial base and national cohesion to pivot more quickly than most countries if and when the public consents to it. But given how long it will take, and how expensive it will be, for Japan to fulfill its inevitable geopolitical role, and given the scale and speed with which threats to Japanese interests are mounting, politically-driven decisions can have a disproportionately large impact. Hence the sense of urgency in Tokyo and Washington to press forward.