The World Through Green Tinted Glasses — Window Guidance

The World Through Green Tinted Glasses — Window Guidance

‘Build back better,’ our betters tell us. And, as ever, they’re happy to tell us what exactly ‘better’ might be too. It’s all about going green.

The European Central Bank has weaselled climate change into its mandate.

The European Union engages in green protectionism, with high pollution goods due to be taxed upon entry into the trade bloc.

The UK government is looking at ‘Jet Zero’ to try and decarbonise flying.

The Financial Times reports that the financial industry is on the bandwagon too:

Investment industry at ‘tipping point’ as $43tn in funds commit to net zero’.


Almost half of global assets under management now linked to emissions pledge.

Even Aussie miners are committing to net zero…

All this is good news, right? What could possibly be wrong with saving the environment?

Whenever governments try to direct the economy as they see fit, it usually ends in disaster.

While the obvious example is the US’s housing bubble — what could possibly be wrong with encouraging home ownership? — it’s Japan’s infamous ‘Window Guidance’ that offers the best insight to today.

Window Guidance is the name given to the semi-official Bank of Japan (BoJ) policy whereby the central bank directed banks to make loans to certain parts of the economy.

Creditworthiness, the ability to repay, or the usual capitalist constraints didn’t matter — the BoJ’s quotas did.

During wartime, it’s obvious why governments and central banks want to direct economic activity. No free-market economy would prioritise blowing up your trading partners over producing toothpaste for them.

But Japan managed to continue the Window Guidance-style of economic management long after the war.

Unlike in the West, where central banks manage overall economic activity, the BoJ got involved in which parts of the economy got how much lending — and thereby which parts boomed and which didn’t.

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Window Guidance was, of course, voluntary, in the same way that many things are voluntary in Japan, but you still have to do them.

Originally, Window Guidance was used to command and control the economy and keep it on a level base.

Unlike its counterparts in Europe or North America, the BoJ was an instrument of the government’s industrial policy.

But as the Japanese bubble economy got going in the 1980s, the BoJ began to use Window Guidance to pressure banks to lend to keep the bubble fully inflated.

One banker recalls that the BoJ would occasionally request more loans than the banks wanted to make — an extraordinary concept in a capitalist economy.

Another recalls that, when Window Guidance ended, bankers simply didn’t know how to lend anymore.

They didn’t know how to analyse risk and return because the BoJ had simply decided where the loans should go under Window Guidance policies.

I see Japanese Window Guidance as an attempt to generate an economic boom in Japan.

But, according to economist Richard Werner, an expert in the area, it was a deliberate attempt to trigger a crisis there.

The idea was that Japan needed economic reform to become more like the US.

However, this could only happen in the context of a crisis, when people are more open to radical shifts.

And so, the bubble was inflated by the BoJ, using Window Guidance to create that crisis.

The film and book Princes of the Yen is, in my opinion, the best source on Japan and its Window Guidance directed bubble and bust.

If Richard Werner, the book’s author, is correct, it’s ironic that the BoJ’s crisis creation policy is also a favoured tool of climate change-motivated economic management today.

Over in the US, the central bankers and politicians forgot that a crisis followed a bubble when they began to channel irrationally large quantities of money to housing in the years before 2008.

The US form of Window Guidance was a little more political than in Japan, too. But the idea was similar.

Politicians made laws and established semi-government entities like Fannie Mae and Freddie Mac to try and support home ownership by making debt available to low-income households.

The central bankers at the Federal Reserve obliged by keeping interest rates low to keep that debt affordable.

And so, money flooded the sector, creating a bubble.

The bust, as they say, is now history. But it’s another example of how directing credit into politically important sections of the economy causes a bubble and a bust.

Today we’re making all the same mistakes by trying to engineer a Green Bubble with Green Window Guidance.

Central bankers are making climate change a key part of their raison d’être.

The European Central Bank explicitly does this thanks to the recent review of its mandate. And it is looking into buying so-called green bonds.

This is very close to the idea of Window Guidance.

The idea that central bankers should worry about climate change instead of inflation and the banking system is absurd.

But that won’t stop them.

And it won’t stop the financial industry from profiting from the central bank-backed trend — at least for a while.

What’s so wrong with Green Window Guidance? Why will it end in disaster, the same way Japan’s bubble economy and the US housing bubble did?

Directing economic activity, especially credit, leads to bubbles in parts of the economy that get more credit than they otherwise would.

In the US, it was housing.

In Japan, it was banking and export industries.

This time, it’s Green Tech.

But the specific direction doesn’t matter.

The principles are the same.

The underlying concept is that a free-market economy evolves and allocates capital in the most efficient way possible.

That is to say: not perfect, but better than any other possible mechanism.

And any mistakes are not systemic because there is no system-wide influence like the government or central bank making credit allocation decisions.

If governments or central banks get involved in allocating credit, this can shift the economy away from that efficient allocation. And you get clusters of errors because entire industries get too much credit. A bubble, in other words.

Bubbles look like booms at first. But they eventually burst.

When a bubble bursts, the economy isn’t in crisis: it’s healing.

It’s reallocating the capital back to where it should’ve been in the first place, without government planning and misallocation.

Of course, this is never allowed to happen. Central banks and governments prevent the healing with even more policies and even more misallocations.

That’s why economies struggle to recover, with growth in Japan, Europe, and the US slow compared to historical recoveries after bursting bubbles.

The wealth that can be created during a Window Guidance influenced bubble is, of course, vast.

The stories about Japan are even more extreme than the riches created during the sub-prime bubble.

Land values soared completely out of control in Japan, and huge Japanese investment in foreign assets led to Australian school children learning the language as part of the core curriculum…

But the damage of the inevitable bust shouldn’t be overlooked during the boom.

Japan is still deeply scarred from the end of the bubble, despite it bursting about 30 years ago.

And countless Australian school children wasted a good chunk of their lives learning a language they never got to use because Japanese tourism and investment dried up once the Japanese bubble burst.

The Japanese town I’m living in was once an airport hub for Japanese executives going on spa weekends with their mistresses. The many spas are now run down and operating at fractions of the capacity.

These days, Australian children are learning all about climate change instead of Japanese.

I wonder if history will repeat and, by the time they grow up, the Window Guidance mistake will be exposed, and the business of climate change will have gone bust.

Let’s hope the environment survives the government’s attempt to save it…

Until next time,

Nick Hubble Signature

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend

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