By Ambrose Evans-Pritchard,
International business editor6:00PM GMT 20 Jan 2013
So Japan may not slide into genteel oblivion after all. To the
surprise of the Japanese people, their country is smack in the
middle of two riveting dramas that threaten to upturn the global
strategic landscape in short order
Newspapers may soon have to re-open their Tokyo bureaux, shut
down long ago when the investment bubble burst and one Lost Decade
stretched into another.We all watch with disbelief as China and
Japan rattle sabres over the Senkaku/Diaoyu islands, so like the
seemingly minor events that drew Europe’s alliance systems into
conflict from 1911 onwards.
Both graduated to fighter jets last week: Japan sending in F-15s;
China deploying J-10s, and mobilising the East China Sea fleet for
live ammo drills. China’s purpose is clear. It is testing the US
security umbrella, and Washington’s willingness to risk conflict
to back Asian allies. There is a minority in Beijing who think
America is a busted flush, a mistake made repeatedly by different
powers over the last hundred years. The possibility that the
world’s three largest economies could come to blows — as feared
by US defense secretary Leon Panetta — is a sobering thought.
Against this, Japan’s economic policy revolution seems tame. Yet
forces are being unleashed that could have powerful effects
through the world’s asset markets and trading system.
Premier Shinzo Abe has vowed an all-out assault on deflation,
going for broke on multiple fronts with fiscal, monetary, and
exchange stimulus. This is a near copy of the remarkable experiment
in the early 1930s under Korekiyo Takahasi, described by Ben Bernanke
as the man who “brilliantly rescued” his country from the Great
Depression. Takahasi was the first of his era to tear up rule book
completely. He took Japan off gold in December 1931. He ran “Keynesian”
budget deficits deliberately, launching a New Deal blitz before
Franklin Roosevelt took office. He compelled the Bank of Japan to
monetise debt until the economy was back on its feet.
The bonds were later sold to banks to drain liquidity.
He devalued the yen by 60pc against the dollar, and 40pc on a trade-
weighted basis. Japan’s textile, machinery, and chemical exports swept
Asia, ultimately causing the British Empire and India to retaliate with
Imperial Preference and all that was to follow — and there lies the
rub, you might say. Takahasi was assassinated by army officers in 1936
when he tried to tighten by cutting military costs. Policy degenerated.
Japan later lurched into hyperinflation. Few dispute that Japan escaped
from slump and pioneered the world’s most successful policy mix — in
strictly economic terms — from 1932 to 1936. The trick was to act with
overpowering force and combine all forms of stimulus, each leavening the
other.Monetarists say Japan’s great mistake over the last 20 years has
been to launch one spending spree after another without monetary backing,
like sending infantry over the top deprived of artillery support.
The result has been to push net public debt to 145pc of GDP this year
(gross debt is 245pc) without reaching “escape velocity”.
The Bank of Japan sat of on its hands for a decade. Only later did it buy
bonds, but in dribs and drabs, on short maturities, from the banking system
instead of the broader public, and all in a half-hearted spirit. Mr Abe has
lost patience. This time the Bank of Japan (BoJ) will do what it is told,
the first of the big central banks to be stripped of its independence, and
probably not the last. As Milton Friedman said — quoting Clemenceau —
“monetary policy is far too important to be left to central bankers”.
Mr Abe said the next governor to take office in April must be a soulmate
“with the will and ability to pull the nation out of deflation”. Leaks
suggest that the BoJ will set an inflation target of 2pc this week, to be
achieved by unlimited bond purchases. The liquidity effects of this by the
world’s top external creditor could be large enough to leak into everything
from New Zealand bonds, Brazilian equities, and Chelsea property, a sort of
`carry trade’ on steroids.
On the fiscal side, Mr Abe will launch combined national and local stimulus
worth 20 trillion yen (£140bn) or 4.4pc of GDP. No matter that the budget
deficit is already 10pc of GDP, or that total financing needs are a record
60pc of GDP this year.The IMF advises Japan not to push its luck, warning
that the country has reached the point where even a “relatively small” rise
in borrowing costs could set off havoc.”Europe’s recent experience offers a
cautionary tale. Once market confidence is lost, regaining it becomes very
difficult,” it said.Mr Abe cares not a wit about such opinions, but he is
taking a huge gamble. Japan is losing its safety buffers one by one. The
trade surplus has evaporated, and will not recover soon after post-Fukushima
closure of the nuclear industry. The savings rate has fallen to 2pc from 15pc
in 1990. The work force is shrinking every year.The state pension fund has
become a net seller of government bonds as the aging effect reaches a critical
point. Japan’s banks have become the buyers or last resort instead,
pushing their holdings to 85pc of GDP. The result is to starve small firms of
credit. Adam Posen, a former UK rate-setter and a Japan expert, says fiscal
stimulus ceased to be any help a decade ago and is now counter-productive.
The risk is not that Japan’s debt trajectory will fly out of control. The damage
is slow and insidious.” When a large country with its own currency reaches its
fiscal limit, growth ends not with a bang but a whimper of declining vitality,”
he said. Mr Posen advises Japan to rely on monetary policy alone to right the ship.
I broadly agree, though this time the kindling wood of fiscal spending may be what
is needed to ignite damp money. If Mr Abe means what he says, this is not just
more of the same.
Needless to say, printing money has its perils too. The risk is that Japan could
escape gentle but stable deflation — the Devil it knows — only to see a panic
flight from bonds that overwhelms the Bank of Japan. As Governor Masaaki Shirakawa
told the Diet through gritted teeth, “long-term yields could rise, and that would
be a problem for public finances.”
Banks hold JGBs worth 900pc of their Tier 1 capital. Their portfolios would be
decimated if long rates punched above 2pc. Japan might then face a banking disaster
as well. These are the hard choices that Mr Abe has to make.
Nor can he continue to weaken the yen without irking Washington and jeopardising
the alliance on which he depends. His rhetoric alone has already triggered a 12pc
fall in the yen against the dollar, and a 20pc fall against the euro. He seems to
be eyeing a dollar rate near Y100.
Mr Abe’s frustration is understandable. Japan is cursed with a safen-haven currency
that strengthens in times of trouble when least wanted, the cross that creditor states
must bear. Japan did uphold the G20 deal in March 2009 to refrain from “competitive
devaluations”, when others did not.
But should Japan now buy foreign bonds on a mass scale to suppress the yen, there
will be trouble. Tokyo will be blamed as the aggressor in the outbreak of currency
wars. Others will retaliate. Huge issues are at play here. The world’s trade system
is fragile. The wasting disease behind the Long Slump is a record high savings rate
of 24pc of global GDP, and too little demand to go around. Everybody wants a weaker
a currency. They can’t all have it.
Japan’s great experiment cuts both ways for the rest of us: the reflation blitz helps
lift the global economy out of the doldrums: but yen manipulation snatches market
share, incites protectionism, and takes us into the brave new world of “actively
managed exchange rates”, as Sir Mervyn King put it last month.
We will find out soon enough which is the more powerful effect.