FYI | Dec 21 2012
By Greg Peel
“We think this could be the beginning of a fresh reflation cycle for the global system,” BNY Mellon's Simon Derrick told the London Daily Telegraph, “combining with the US recovery to mark a turning point in the crisis”.
If we don't count the eurozone as a bloc, Japan is still the world's third largest economy behind China and ahead of Germany. Yet despite the influence of the Japanese economy on the world, and notwithstanding the 2011 tsunami and its aftermath, Japan does not really get that much attention. This is particularly true in Australia, where everything is China, China, China, yet Japan remains one of Australia's most important trading partners.
The reason is because Japan's economy bubbled and burst – spectacularly – in the early nineties and has never recovered. For fifteen years the country has seen no growth in nominal GDP. The Japanese deflation experience has been held up by central bankers such as Ben Bernanke as a model of “what not to do”. The general opinion is that Japan's governments and central bank have done everything pretty much wrong since the nineties crash which sent property prices plunging and knocked the share market down 75% – a level from which it has never meaningfully recovered.
The “Japan of the twenty-first century” – China – has grabbed all the attention. Europe has been the focus since 2010. And the US, as the world's largest economy, will always be in focus. Meanwhile Japan just bungles along in a stable, or as the Telegraph's Ambrose Evans-Pritchard puts it, “almost comfortable”, equilibrium in which the value of “real” savings rises beneath the deflation perma-frost.
But all has not been well. Despite the rising real value of Japan's extensive savings, the future obligation to a rapidly ageing population is becoming overwhelming. As a manufacturer nation, with as good as zero natural resources, Japan has long been a surplus, or creditor, nation. Yet global QE, particularly from the Fed, has pushed the yen so high as to make Japanese goods unaffordable. And, combined with the recent Chinese boycott due to the territorial dispute, and fuel exports required to replace suspended nuclear energy, has sent Japan's trade balance into rare deficit.
The Japanese Ministry of Finance, via the Bank of Japan, has fiddled around the edges of currency intervention to date. Yet after each brief reversal, the yen has powered back on fresh QE from the Fed, OMT from the ECB and monetary stimulus across the globe. Japan is in trouble, and that's what prime ministerial hopeful Shinzo Abe told voters during his election campaign. It is unusual for a politician to draw on the ethereal world of monetary policy as a major election platform. But that's exactly what Abe and his LDP party did –successfully.
Very successfully. The LDP is now back in a landslide, and with coalition support will command a “super” majority in excess of two-thirds when the new government is sworn in early next year. A super majority gives the lower house the power to overrule the upper house in most cases. Abe may not immediately exploit this power nevertheless, particularly in matters of sovereign finances, lest he be seen as a tyrant. If he waits for the upper house election due mid-2013, he will likely gain a majority in both houses. Then he can really do what he wants with impunity.
And what he wants to do is once and for all kick-start Japan out of its long deflationary malaise. He wants to lift Japan's inflation target to 2% from 1%. He wants to replace 15 years of no growth with 3% GDP growth in 2013. And to do it, he is happy to use unlimited monetary stimulus. He will just keep printing till the job is done.
Switzerland suffered a similar fate to Japan in the wake of the GFC. As the Swiss franc rose sharply against the US dollar and euro, the Swiss National Bank was forced to swiftly and decisively intervene in currency trading. The effect of Switzerland's unlimited bond purchases, notes Evans-Pritchard, has been to finance most of the eurozone's budget deficits for the last year with printed money.
“If Japan tries to do this – with a vastly bigger economy – it would amount to a blast of quantitative easing for the world”.
Says Evans-Pritchard, “The profound shift in economic strategy by the world's top creditor nation could prove a powerful tonic for the global economy, with stimulus leaking into bourses and bond markets – a variant of the 'carry trade' earlier this decade but potentially on a larger scale”.
Professor Richard Werner of Southampton University told the Telegraph, “This [existing Japanese] tight-money, loose fiscal mix has pushed public debt to 240 percent of GDP. The country would have been better better served if Bank [of Japan] had stopped the rot immediately by flooding the money supply to kick-start lending. It has taken 20 years and the Fed's Ben Bernanke to show them how to do it”.
Abe's initial plan is to step up budget spending, most likely through infrastructure, which will naturally increase Japan's debt ratio. But then he intends to open the yen floodgates to debase the currency and, in so doing, effectively reduce real debt. To do this he will need to have the independent Bank of Japan onside, and to achieve that he may need to wait until the present governor's tenure expires.
Says Dennis Gartman of The Gartman Letter:
“The point here is…that the LDP and Mr. Abe are now in firm… very, very firm…control of the government. Their platform was and is one of lesser taxes, of a trend toward smaller government, of a far more assertive and militarily prepared Japan and of a turn back toward nuclear power rather than openly away from it. Mr. Abe has made it further clear that his primary concerns shall be with the policies of the Bank of Japan; that the Bank is forced to pursue policies intent upon ending Japan’s two decades of deflation by inflating the Bank’s balance sheet aggressively in “unlimited” fashion as Mr. Abe made clear time after time after time again on the campaign trail. He has made it clear that his Ministry of Finance and his Ministry of Economics shall be involved in BOJ policy making and that Mr. Shirakawa, the present Governor of the Bank of Japan almost certainly shall not be reappointed to his position when his term in office expires in April of next year.”
With the Japanese upper house elections not due until mid-year, it is clear Abe's economic kick-start will be a story played out over 2013, rather an an immediate jolt.
It is also a real possibility Abe will seek to postpone the previous government's mandated 2014 consumption tax hike. This is where we begin to consider that the new Japanese government's polices are not without risk.
Japanese government bond yields will be under upward pressure with talk of more spending and aggressive policies to achieve higher inflation, the ANZ Bank economists note. While the government's capacity to spend is constrained by the already sizeable debt burden, “The possibility of a higher risk premium is distinct,” says ANZ.
And if Abe does indeed postpone the 2014 consumption tax increase, the suggestion from economists is that Japanese sovereign debt may well suffer a credit rating downgrade, which could blow out yields on JGBs substantially. This would put Japan's banking system under severe strain given Japanese banks loaded up their balance sheets with JGBs post-GFC.
On that basis, “The markets could start to question whether 'Abenomics' is consistent with long term debt sustainability,” suggest the economists at Danske Bank.
Ben Bernanke reiterated at his last monetary policy press conference his admission that his QE policies represented a brave new world of untried central bank manipulation. They offer up something we might call “vu deja” – the strange feeling that we've never been here before. Bernanke is effectively asking Wall Street, and Main Street, to come along on his journey. We just might find out what eventually happens.
The problem is that Bernanke's journey is forcing every other central banker down a similar path, from a return to an “emergency” RBA cash rate through to what Shinzo Abe intends to unleash on the world. If one nation “prints money”, other nations must follow suit to maintain the balance. Some argue that with all this exchange rate-cancelling money flooding the global system, it is impossible for the global economy not to recover.
Others paint a darker picture. But whatever the case, we can rest assured that alongside our old friends the US, Europe and China, 2013 will be the year we start talking about Japan.
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