To sum up where we were at the end of Abenomics 101, I give you Japan in the early 1990s:

  • the credit-driven asset bubble had burst rather dramatically;
  • the Finance Ministry, having precipitated the crisis with interest rate hikes, is now furiously backtracking;
  • And Japan’s banks and insurance companies are snowed under with bad debts,
  • Requiring them to be bailed out by the Japanese government.

Hello The Zombies

If you’ve ever heard the phrase “Zombie bank” – it originally referred to these bailed-out Japanese banks that were basically surviving off Government capital injections. These Japanese banks, in turn, kept sustaining the large industrial firms (“Zombie firms”) – on the premise that they were…wait for it….too big to fail!

Unfortunately, with those high (and growing) levels of debt, the big firms just continued to let themselves be sustained by credit. Which, when you think about it, is exactly what anyone would do in that situation.


  • You owe the bank more money than you can repay;
  • Even if you take on an extra job, all that money will just go straight to the bank (how depressing!).
  • But the bank is happy to regularly increase your credit card limit.
  • Would you get the extra job to try and clear the debt?

Probably not, right? Even if you’re sinking even deeper into the debt mire – provided that the bank keeps extending your credit limit, you’ll just defer and deflect the problem for “future me”. Also – with near zero interest rates – it really made no difference for the Zombie firms.

But here’s a more pressing question:

What if you’re not Too Big To Fail?

Well if you were a Japanese firm that was deemed small enough to fail, then the banks weren’t lending to you. Which leads to another, even more pertinent question: why on earth would a bank lend you money at near 0% interest?

The answer to that is: they probably won’t*.

Meaning that the small to medium-sized firms which normally sit at the heart of a functioning economy lost their capacity to grow. And the Japanese, in their magnificently philosophical way, became masters of frugality for the next two decades.

The Liquidity Trap

In and around the turn of the millennium, Paul Krugman, Ben Bernanke, and a few of their fellow economists became fascinated with this Japanese dilemma. And they began to talk about “Liquidity Traps”.

A Liquidity Trap, according to the Keynesian school, occurs when people hoard their money (instead of spending it) because they anticipate deflation (ie. a dollar today will buy more stuff in a week’s time – so let me just hold onto it). And it’s a situation where increases in the money supply through quantitative easing don’t/can’t lower interest rates, and therefore the quantitative easing fails to “stimulate economic growth”.

At this point, a Keynesian would whip out an IS-LM model** and try to explain it with moving lines and such. I find those diagrams really confusing to understand, and even more confusing to explain – so let me try and explain it with an analogy. Before I can get there, let me set the stage by giving you an analogy for monetary stimulus that “works”:

  • Let’s say that you just binged out on a massive meal – roast beef, honey-glazed pork, whole baby chickens, cherry flans, berried pavlovas filled with almond cream, baked custards, and so on.
  • So good, in fact, that you ate to the point where you threw up. Loudly and noisily, across the table. And the air is now layered with the biting acridity of fresh bile.
  • You’re feeling ill, your mouth tastes like vomit, and that’s all you can smell.
  • You really don’t feel like doing any more eating.
  • Luckily, your parent is a doctor – who is entirely unsurprised at your physiological reaction to the over-eating. Of course there was no way to tell which leg of deep fried chicken would be the one to toss you over the edge – but he knew it was coming.
  • And being a doctor, he is prone to treating illnesses. So he is now worried that you’ve just thrown up all your calories, and he really wants you start eating again.
  • He gets your mom to bring over a kidney and liver omelette with a side of haggis (high protein, low carb).
  • But you flat out refuse to eat it. It may actually smell worse than the vomit.
  • At this point, he’s now getting really concerned; so he arrives with a slice of chocolate cake, freshly iced with belgian 70% and hazelnut praline. You can almost taste the warmth of cocoa-buttered sponge.
  • Fortunately, the scent of the cake is enough to tempt you into the first slice. And very quickly, the chocolate wipes away any residual taste of bile, and you’re on your way to eating again (not necessarily healthily – but the primary concern is just to get you eating).
  • Now that you’re back in the game, he’s hoping that you’ll be able to put the chocolate cake aside, and eat the omelette.

The above is an analogy of monetary stimulus working. The economy has over-consumed, and now doesn’t really feel like eating any more. Maybe it could last for a while by not eating and losing some weight – but that could be dangerous. Especially if, heaven forbid, that turns the economy anorexic!

So the Federal Reserve tries to tempt the economy back into consumption by offering deliciousness (more money at really low rates of interest). The better and healthier calories, like offal omelettes (reform), are probably too much for the economy to stomach just after a crash. Even if it’s what the economy really needs, it could make it bring up again. So the general idea is: once the economy is back to consuming, then everyone can try to get some reforms in place to make whole process healthier.

Whether that actually happens is a completely different subject altogether.

But back to liquidity traps. What would have happened instead?

  • Your puking process is so violent and ravaging that your throat is burned by the acid.
  • You’re physically unable to eat any more.
  • And it doesn’t matter how delicious the morsel might be – you’re just not interested.
  • If enough time passes, the lack of calories makes you too weak to go in search of food.
  • So you miss out on more calories.
  • Which makes you even less likely to go in search of food.
  • And you end up trapped in this cycle of not eating making you unable to eat.

So that’s one of the main theories out there on Japan’s current situation. That they’re not spending which is making their economy deflate. And because their economy is deflating, people have no incentive to spend.

Two decades on, Japan is bracing itself for a whole host of new stimulus measures under Shinzo Abe – in the hope that this situation can actually be fixed. Or cured?

Which I’ll get to in Abenomics 103…

But the point is – this is a real concern for the economies of the US and the Eurozone. That actually, this most recent crash might be like the 1929 one that preceded the Great Depression. Where the recovery process could flip into a completely different sort of crisis (anorexia?) when the problem is no longer physiological, but psychological…

*And even if they did lend you the money, would you put the money into the Japanese economy, or borrow in Japan at 0% interest and invest in a healthy vibrant economy elsewhere?

**I for Investment, S for Savings, L for Liquidity Preference, and M for Money Supply.