There was another gargantuan sell-off in the Japanese stock market overnight. This drop--the Nikkei index fell 6.35 percent--follows an even larger 7.3 percent tumble three weeks ago. Overall, the index has moved more than 3 percent on seven of the last 15 trading sessions, and the yen, Japanese government bonds, and securities in other Asian nations have also shown much higher-than-normal volatility. Here are four reasonable questions to ponder about these wild ups and downs.
So what the heck is going on? Japan elected a new government, led by Shinzo Abe, in December, and it is carrying out Keynesian shock therapy on that nation's long-stagnant economy. Fiscal stimulus, check. Large-scale money-printing by the central bank, check. Pledging to do whatever it takes to get inflation up to 2 percent after two decades of fallng prices, done. Markets have responded just as one might expect (and, if you're Abe, hope). The stock market is way up, making Japanese citizens wealthier. The yen is way down, making Japanese exporters more competitive. But those trends have reversed quite a bit in the last three weeks. Including the steep decline in Thursday's trading session, the Nikkei is down 20 percent since May 22--but remains 28 percent above its level in early December.
Are the markets being rational or irrational? Here's the case for rationality: The rally is being driven by changes to policy, and there have been some small hints that the Abe government and Bank of Japan will not be as resolute as they had previously suggested about keeping the foot on the pedal of stimulus. So the gigantic swings could be the result of logically extrapolating small hints out of the government and central bank as meaning big changes in what will happen in the economy. The case for irrationality goes like this: A bunch of hedge funds had all piled into the same trade, riding the steep appreciation in stocks and decline in the yen to unprecedented levels, and momentum effects are happening where they all start to unwind their trades at the same time, creating a self-reinforcing downdraft. This seems to fit the data better, as it's hard to conclude that the 6 percent overnight drop Thursday or 7 percent drop three weeks ago could be justified by any specific piece of news about the outlook for policy.
So is Abenomics failing? It's way too early to draw that conclusion. Markets seem to be hyperventilating in reaction to the smallest, subtlest signals out of government. But stock prices are still way above their levels of six months ago and the yen is a lot lower, so the fundamental channels through which this new strategy aim to prop up growth are still in place. The referendum on whether Abenomics succeeds or fails comes not from what happens to markets on any one day, but whether those moves in markets translate into growth in the real economy. So Abenomics will count as a failure if, in the months ahead, we see a stagnation or decline in Japanese GDP growth, per capita incomes, or deflation--not because markets have become more wobbly.
Does it matter to the rest of us? Maybe not. Wednesday evening, as the rout began in Japan, Twitter was full of breathless worrying about a new global panic. But now? Well, the British market is down 0.25 percent, the German market off 0.9 percent, and the Standard & Poor's 500 down 0.1 percent. Bond and currency prices in Europe and North America are similarly showing only the slightest of moves. Contrast that, for example, with the eurozone crisis, in which all world markets shook on the latest sign of progress or regression on solving that continent's problems, or the 2008 financial crisis that began in the United States and whipsawed all global markets. In this time of tumult, by contrast, what happens in Japan seems to stay in Japan.