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.