The best way to destroy the capitalist system is to debauch the currency.
– Vladimir Lenin
Barataria was a bit skeptical about Japan’s “Abenomics” back in January. The first results are in, and they are amazing. Their economy grew by a developed-world-leading 3.5% in the first quarter, and the stock market is up 28% in 2013. It’s been called a “wealth shock”, and it’s very welcome in a nation that has been flat for two decades. What could possibly go wrong? Just about everything – and it’s likely to affect us here in the US. Ready for really cheap electronic gadgets? How about stagnating employment?
In just a few months, Japanese Prime Minister Abe has pulled off something of a miracle. The massive borrowing and printing of Yen has brought the economy back to life, and it’s being noticed by their neighbors and around the world. If nothing else, the success has killed talk of austerity everywhere, but it has started to fire up the previously quiet currency war that plagued the world. It takes some time to explain how it has worked so far – and why it’s damned dangerous.
What has been done is a simple matter of running up a tremendous amount of government debt, financed by issuing more government bonds. Rather than throw those bonds to the market, the (somewhat) independent Bank of Japan has been buying most of them with Yen that they are printing in their own quantitative easing program. This is exactly what everyone else in the developed world has been doing, but what’s new in Japan is the scale – 10% of Gross Domestic Product (GDP) into the system overnight.
That’s very similar to what the US slouched into in 2008, but there are two key differences – we started with a total debt of 65% of GDP and Japan is starting with debt of 245% of GDP. Also, the US decided this was a bad thing and recently cut it back to only 4% of GDP.
To understand why this is dangerous, we have to think through the process a bit. The worst thing that can happen is that all the Yen being printed drive down the value of the currency, which has fallen 17% so far this year versus the US Dollar. But that’s a positive effect in a nation that wants to start exporting again to finance this expansion of their economy and provide more jobs. They really can’t lose as long as the Yen keeps falling, making Japanese goods cheaper.
Where it gets sticky is all that debt they already have. 24% of all revenues already go to pay existing bonds. Much of the debt they are accumulating now is going to pay that interest, essentially, meaning that they are floating bonds that can only be paid off by more bonds being floated in the future. It’s become a very big Ponzi scheme, less the amount that is being bought by the Bank of Japan.
It’s unlikely anyone else will buy these bonds because inside Japan major pension funds are in net payout mode as the population has become very old. Outside of Japan, no one would ever buy these bonds because they are almost certain to fall in value. That means that supply is exceeding demand, so if the Bank of Japan can’t absorb all of it those bonds will have to fall in value – which is the same as increasing net interest rates. They have already gone up 0.3% in the last month and could keep rising.
That causes two problems – it makes capital more expensive for big Japanese companies, and it increases the cost of interest for the Japanese government that is already living beyond its means. The problem should only accelerate.
Why should we care? Because the only way out is to keep dropping the value of the Yen, buying that government debt, and making exports even cheaper while flooding the world markets with cheap Japanese products. That is almost certain to happen as fast as factories can be cranked up. Through this, Japan will essentially export the lingering deflation that they had for 20 years and make it the rest of the world’s problem.
What will other governments do? Print their own currency to stem deflation, greatly accelerating the currency war as every nation with an unemployment problem races to destroy their own money.
Where does it end? It’s hard to say. If Japan’s manufacturing can’t keep pace with the new debt they may not make it too far into this program before they default. That would cause a serious depression.
This will reverberate around the globe –and as of now, we still don’t know just how South Korea and China are going to respond. If they become as aggressive with their own currencies the pressure on us will increase. Will we have to debase the US Dollar to keep pace? That would be an interesting way to end problems of wealth inequality, but it’s a way to do it that we can be sure Lenin would approve of.
I haven’t been following this as closely as you have but I do think you are overreacting here a bit. What do you think the effects will be on the price of Japanese cars, Korean cars and exports to China, India and Brazil?
Perhaps I am over-stating the problem, but for the US we have to be worried about the worst-case scenario. I don’t think it affects us outside of that – but that worst-case is pretty bad. I’d like to see more manufacturing here, as I’ve said, but that’s going to be very difficult.
Cars may indeed become cheaper as the Yen drops. Korea has to respond, too, so we will just wait and see. Exports are going to be more expensive, yes, but a lot of what we export are agricultural products that nations rely on to feed their people so they may not be affected as much.
I am with Dan on this one. The last time you talked about this it was more balanced. They had to do something and everyone knew it was risky. Good results so far might continue and everything will work out. I doubt this impacts us at all because we are never going to make flat screen TV’s here anyway.
I am thinking a lot more about this, and there is much more to say. I’ll balance this out with a more global perspective once it’s been thunk out a bit. 🙂
Currencies are so hard to understand so I will admit I don’t get most of this. It’s not like regular accounting at all. They can print more money and it just seems to go out into the world like nothing. I guess if what you are saying is that the important part is how the rest of the world responds I will agree with that but Japan seems to be its own island. If electronics become cheaper I don’t think that will affect us really in any way other than to be a benefit to the retail sector.
What if they can’t keep borrowing and do collapse? I would want to hear more about that. I think you are right that they buy mostly farm products from us and I heard Alaska oil too. That doesn’t seem like it would hurt too badly no matter what.
It is a very different world – inside a nation is one thing, outside is another. Everyone is thinking about both at the same time here, but all politics is first and foremost local.
What happens if Japan has to default and/or the Yen really does turn into toilet paper? That’s what “collapse” is, and I don’t know that anyone has thought that through to the end.
I’m starting to think you guys are right about cheap electronics – it doesn’t affect us at all.
I guess what I wrote was off a bit. My theory is the Japanese and possibly Korean automakers want to get their product into Brazil, China and India. As there is profit after the sale in parts, service and trading up.
I think you are right on, except it’s more than cars. The growth is in the developing world, and they want to be positioned to take advantage of that. You guys are making me think a bit more and I appreciate that. A lot!
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Hemingway said it best “never mistake motion for action”. Historically, Japan has been content with moving money instead of actual growth. It is very much been, like you say, a “ponzi scheme”. Perhaps, it is too soon to tell if Abe will successfully change the game, but we should follow the developments in the Land of the Rising Sun. Further, let us not overlook that Abe, unlike his post-war predecessors, has a definitive nationalist streak. Abe his clamored for the Japanese security apparatus to evolve from its current self-defense status. Further, with a hostile China and an outright militant North Korea, external forces may accelerate the re-militarization of Japan. With plans to re-militarized, a reinvigorated economy and a rekindled nationalist spirit, Japan could easily return to great power status. Of course, this could cause a tremendous impact in the international system.
We quickly overlook the United States and Japan fought for domination of the Pacific Ocean World War II (not an honor feud for Peril Harbor). Both maritime states, neither America nor Japan could risk allowing the other to dominate this body of water. Both had a clear incentive to fight the second world war. The only reason the peace lasted was because Japan definitively fell from the ranks of the great powers. But with Japanese power on the ascent, we cannot guarantee that this piece will last. Therefore, it is good of us to turn our attention to Japan now. Hopefully, by understanding all the dynamics behind the Japanese resurgence and the structure of geopolitical in the Pacific, we may pursue policies that avoid future conflicts.
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