So if you haven’t already, here is the background to Japan and why she’s suddenly so important in the world:
- Abenomics 101: where Japan gets plenty of credit, has an asset bubble, and then collapses.
- Abenomics 102: where I get to describe a liquidity trap economy in terms of food
- Abenomics 103: where Japan loses two decades, and what the Japanese authorities did to get out of them, and why it still hasn’t worked.
Which is enough background (I think) to get to Shinzo Abe, and his new solution: Abenomics.
The Brief Recap
So throughout the period since the bursting of the asset bubbles, plenty of things have been tried by the various Japanese governments and Bank of Japan governors: quantitative easing to punish savers, bank bailouts, increasing government spending to try get people working, keeping the yen weak… None of it very successfully.
The Problems Faced By Japan
- An Aging Population: Firstly, this is a problem because it results in fewer workers, and here’s an equation: production = labour × labour productivity × capital resources. Alternatively: production = number-of-workers × how-well-they-work × how-much-stuff-they-have-to-work-with. When you start running out of workers, then whoever is left has to work really well – only, that’s not so easy to do in practice. And I haven’t even gotten to the second part of the problem: which is that old people like to save more than they like to spend. If you’ve retired, your money between now and death is relatively fixed. And death, while certain, is of uncertain timing.
- Deflation: people have gotten used to saving. And if you’re facing deflation, it makes sense to save (for both governments and households) – because when prices fall, you’ll be able to buy more with your saved yen. And the more people save, the more prices fall. Here’s a graph of overall savings in Japan as a percentage of GDP (just pay attention to the green line – which you’ll notice has been above 0% since 1992):
- High Deficit Spending Already: the problem with accounting, even on a national scale, is that all things must balance (it’s practically Newtonian). In order to counteract the savings taking place in the Japanese Economy, the Japanese Government has had to spend more (the blue line – which is almost the mirror opposite of the green private-savings line) in order to try keep the economy (as measured by GDP) from contracting. For a particularly great post on how government deficits link to public savings and trade surpluses/deficits, check out bilbo.economicoutlook.net by Bill Mitchell (I sneaked the above graph from his post).
- The highest Debt-to-GDP ratio in the World: that government spending had to be financed from somewhere. And high government spending + constant GDP = rapidly accelerating Debt-to-GDP ratio. Which many people say isn’t such a problem – because Japanese government debt is denominated in yen, and Japan still retains the ability to monetize that debt rather than defaulting (ie. they can just print the money to pay it). That may be true – but government debt is a bit like a tightening straightjacket. Here’s an example: Japanese Government Bond (JGB) yields are near zero. Let’s say that the market decides that Japan is actually at risk of losing control and pushes the yields up to, say, 2%. By some estimates (not sure about the math – but here’s hoping they’re correct), 80% of all taxes collected would then go toward covering the interest cost. Sure – they can monetize it. But that is being pushed into a corner where there are no other solutions.
- A Strong Yen: the other thing that was helping Japan cope was their cheap exports (made possible by a weak Yen) – meaning that they could “export” some of their deflation (if other countries provide the demand for Japanese products – then the Japanese economy gets boosted without the Japanese people having to change their deflationary ways). You can see that trade surplus (exports > imports) happening in the red line. But that changed when the Yen started appreciating in 2008:
- Falling Global Demand: oh yes – and as cheap as exports are, if there’s not enough global demand for them, that’s a bit of an issue…
- Other Countries: so one of the policies (getting to them now) is to dramatically weaken the Yen. How happy is the rest of the world going to be if their local markets are flooded by cheap Japanese exports, causing their local producers to suffer? Do we think that they’ll just sit back and allow Japan to fix herself at their expense?
So in the face of all the above problems, here is what Shinzo Abe is putting in place:
- All the same policies as Japan has been trying for the last 20 or so years – only, steroided up.
- A devaluation of the yen by 15-20% per year, every year, for the next 5 years.
- Which means a rapid and radical monetization of Japanese debt (the plan is to DOUBLE the monetary base in the next two years).
- And aggressive fiscal spending.
- Hmmm. And increasing taxes…
The Krugmanites are hailing this as a regime-shift – a spectacular economic experiment into uncharted waters: hoist the exp
lor atory sales sails and so on. The Bank of Japan and the Japanese Government are bonding together under Shinzo Abe, and committing to be monetarily irresponsible.
What seems so crazy to me is that quantitative easing hasn’t worked anywhere yet (at least, not that I know of). The argument always seems to be “but if America had done this in the Great Depression, things would have gone better”. I guess someone has to do it first… But someone also has to fail spectacularly before we’ll agree that we need a new idea.
And I realise that I’m biased, but when I first wrote about hyperinflation, I pointed out that the ideological shifting point between high inflation and hyperinflation seems to be that moment when a population comes to believe that a government’s primary fiscal policy has become money creation (ie. fiscal and monetary policy conflate).
If Japan is intentionally aiming for that point (which it seems to be doing), I have no doubt that she will hit it. Just like every other government that has deliberately chosen to create money as a fiscal goal (stimulus or otherwise). But there is an extraordinarily high cost waiting on the other side of that policy – if the Japanese lose control of it.
I guess the counter here is that Japan is planning on increasing its consumption tax as part of the Abenomics plan. It’s clever, I’ll admit – because it allows the tax base to keep track with inflation (as opposed to increasing income taxes – which fall behind eventually). And the Japanese are already wary of spending too much money.
But if this doesn’t work, Shinzo Abe will be leaving Japan with an Everest of debt overhang.
PS: if you want to read about the investing implications of the above, this article by John Mauldin was particularly excellent.