You would think that Japan would be a blinding object lesson in the folly of Keynesian economics. After all, Japan has gone all-out on both fiscal stimulus and massive central bank balance sheet expansion and interest rate repression. Indeed, the US incursions into that fantasy world are somewhat modest by comparison: Japan’s gross public debt is 240% of GDP compared to 100% in the US; and its central bank balance sheet of nearly $3 trillion amounts to more than 40% of GDP. That vastly exceeds the 25% of GDP balance sheet generated by the mad money printers in the Eccles Building to date.
But the lessons go far beyond balance sheet ratios. Japan’s rapidly aging demographic profile—-its population is now actually declining— is only an advanced case of the US path over the next several decades. Likewise, its inability to close its yawning fiscal gap—last year it borrowed nearly 50 cents on every dollar of government spending—is a function of the same malady of governance that afflicts the Washington beltway. Namely, the domination of a nominal democratic process by crony capitalist gangs which resist all efforts to curtail privileges, subsidies and entitlements.
In truth, Japan is rapidly become a vast old age home buckling under the weight of a monumental accumulation of public, household, business and financial debt. Current estimates for total debt outstanding amount to nearly 500% of GDP—-a figure which would be equivalent of $85 trillion on a US economic scale.
Needless to say, these staggering debt burdens have prevented Japan from returning to normal economic growth—ever since its giant financial bubble collapsed 25 years ago after the Nikkei average had hit 50,000 (vs. 15,000 today). The aftermath has been described as chronic “deflation”, but the true meaning of that term has been badly twisted and distorted.
What actually happened during the final stages of Japan’s 1980s bubble is that ultra-cheap interest rates caused financial and real estate values to become drastically inflated. Similarly, cheap capital resulted in a massive over-investments in long-lived industrial assets like auto plants, steel mills and electronics plants.
So the deflationary aftermath of its bubble was an unavoidable and inexorable economic process. That is, real estate got marked down by upwards of 80%; stocks fell by even more; excess industrial capacity was steadily eliminated; and massive bad debts have been liquidated by Japan’s unique slow-motion process.
In short, Japan’s actual “deflation” has been overwhelmingly a balance sheet contraction—the inverse of the great asset and debt inflation which preceded it. By contrast, household incomes have only eroded slightly and goods and services prices have fluctuated along the flat-line for more than 20 years. As shown below, the ailments of the Japanese economies were sown in the false boom before 1990, not in plunging consumer prices since then.
Indeed, Japan’s CPI index today—after 17 months of strenuous, but wrong-headed efforts by the Abe government to rekindle inflation—-stands virtually at the exact spot where it stood in early 1993. Moreover, the narrow band of fluctuation in the interim amounts to only a few percentage points around the index base of 100. Ironically, economists a few decades ago would have uniformly praised the price stability path shown below—-not identified it as the root cause of economic evil as have today’s clueless Keynesians.
Needless to say, the false Keynesian “deflation” canard has led to the catastrophe known as Abenomics. In a decade or two, nearly 40% of the Japanese population will be retired. The last thing it needs is zero interest rates owing to the massive monetization of debt by its central bank. And the single-risk it should never take is to induce a collapse of its currency, and the resulting sharp inflation of its import bill for virtually all the energy and industrial materials that the island consumes.
That would eventually result in an actual sharp decline in real household incomes compared to the post-1990 stability; and an outbreak of end-of-the-world disorder in its debt and financial securities markets were CPI inflation ever actually let loose.
Unfortunately, Japan is headed in exactly that direction. As reports on its collapsing balance of payments for the year just ended make clear, Abenomics has caused imports to soar, corporate Japan to off-shore more production, and export prices to rise only slightly without any gains in real volumes.
In short, Japan’s live-fire test of Keynesian central banking against the mirage of deflation has already proceeded far enough to know the answer: It is a world class disaster, yet one that Janet Yellen and here merry money printers seem determined to replicate.
By Mitsuru Obe At the Wall Street Journal
TOKYO—Japan posted its smallest current account surplus on record in the fiscal year that ended in March as structural changes in the economy undermine Prime Minister Shinzo Abe’s efforts to achieve growth through exports.
The ¥789.9 billion ($7.76 billion) surplus in the broadest measure of a nation’s trade with the rest of the world was sharply lower than the ¥4.2 trillion surplus registered a year earlier, data from the Ministry of Finance showed Monday. Until recently, the country routinely produced a surplus in excess of ¥10 trillion a year.
When Mr. Abe came to power 17 months ago, he introduced an inflation target and called for aggressive monetary easing. That helped weaken the yen’s export-crippling strength. But to his surprise, exports have yet to catch fire. So far the weaker yen has merely made imports more expensive at a time when the nation is more reliant on fossil fuel from other countries.
The trend of large surpluses abruptly reversed in 2011, when a nuclear accident forced the shutdown of nuclear plants across the nation, resulting in a surge in imports of fossil fuels.
Japanese manufacturers shifting their production offshore has also exacerbated the situation.
Any additional falls in the value of the yen could put further pressure on the current account, pushing it into deficit as returns on investments overseas fail to outweigh the trade deficit. That trade gap is also expected to widen further as the population ages, the workforce shrinks, and retirees multiply.
A current account deficit means a nation is spending more than it earns from trade and investment. A country that builds up liabilities with foreign creditors through chronic current account deficits could face funding problems if investors decide to withdraw their financing.
BNP Paribas predicts Japan will record an annual current account deficit next year, while Credit Suisse thinks it will happen after 2017.
“Some might hope that the income surplus will continue to widen at a pace sufficient to offset further deterioration in the trade balance,” economists at Credit Suisse said. “But that could prove difficult in practice, given that the world economy is facing a decline in returns,” they added, pointing to the global low rate environment and slower growth in emerging economies.
The recent deterioration in Japan’s trade balance, as a result of slower exports and stronger imports, points to the possibility that this day of reckoning may come sooner rather than later.
“The recent surge in imports was a surprise,” said Takashi Shiono, an economist with Credit Suisse. Some of it may be due to rush purchases ahead of the April 1 sales tax hike, but data for April suggest that a change is more permanent than temporary: Japanese are embracing imported items much more than before, he said.
For now, the Bank of Japan is effectively taking care of Japan’s fiscal woes. By buying up Japanese government bonds at a faster pace than the government issues new debt, the central bank makes sure the supply-demand balance remains tight for JGBs. But with inflation rising on the back of a weakening yen, it’s not clear how long the BOJ will be able to continue its ultra-easy monetary policy.
Having largely giving up on achieving a balanced budget, Japan’s current goal is to stabilize the debt situation by 2020, mainly through sales tax increases, around the current debt-to-gross domestic product ratio of 240%. But according to a government panel report released on April 28, even that won’t be enough to bring the situation completely under control beyond 2020, as baby boomers reach 75, an age associated with a huge increase in medical and elderly care expenses, much of which are funded by the central government.
Some economists argue that there is no need to treat debt owed to domestic and foreign investors differently. No matter who owns the debt, the government’s job should be the same: keeping its debt under control and achieving healthy economic growth, said Takao Komine, professor of economics at Hosei University.
Mr. Komine points to the U.S., which has run twin deficits of fiscal and current account shortfalls for many years.
For the month of March, the current account balance came to a surplus of ¥116.4 billion, compared with a median forecast of a ¥294 billion surplus according to a survey conducted by The Wall Street Journal and the Nikkei.
The current account measures trade in goods, services, tourism and investment. It is calculated by determining the difference between Japan’s income from foreign sources against payments on foreign obligations and excludes net capital investment.
Mitsuru Obe at email@example.com