There’s an old saying: “When you’re in a hole, stop digging.” Japan has been digging itself into a debt hole for over two decades. The hole is now so deep that there’s no way to climb to the top and scramble out. The Japanese solution is to dig harder and faster, burrowing straight down into the Earth, and hoping to eventually come out the other side. Interestingly, if they attempted this literally, the Japanese would emerge just off the coast of crisis-prone Argentina. This does not bode well for a happy ending.
Beneath the clean and well-ordered streets of Japan lurks a severe financial and economic crisis. The country has been in a perma-slump for a quarter of a century. Public finances are shot to pieces. So what to do?
Currency devaluation via money printing is seen as the last ditch hope to turn things around. But it hasn’t been working. The solution? Using the usual logic of public policy makers across the developed world, even more money printing.
OfWealth last wrote about Japan on 17th October, explaining why we’re unconvinced about the investment case for Japanese stocks. And we last wrote about the global addiction to money printing on 3rd October, and the desperate need for rehab. (If you haven’t seen the latter one, then please take a look, not least for our irreverent picture of the world’s most important central bankers.)
On 3rd October I wrote: “The world, especially the developed world, is truly addicted to money printing and debt.” You may have thought I was losing the plot, since it was so close to the impending cessation of quantitative easing in the USA at the end of October (but for how long?). I have to admit I was as surprised as anyone at how quickly a major new injection of the money morphine was announced.
As October 2014 faded into memory, the Bank of Japan shocked just about everyone – and delighted many – by announcing that it was upping the stakes in its ever more desperate attempts to create price inflation. It would print even more money, buy even more Japanese government bonds (JGBs), and all would be fine and dandy.
As the Bank of Japan governor Haruhiko Kuroda said: “We have pledged to do whatever it takes to achieve our two percent inflation target at the earliest date possible.”
Oh, come on mate. I know you’re a central banker, but liven up a bit. What you meant to say was this:
“We’re cranking up the printing presses even further, and will be dumping gobs of yen into Japanese asset markets. We want the yen to fall further and faster against other currencies. This will make things progressively more expensive to buy and encourage Japanese people to stop being so selfish, and to start spending more money. Because they’ll be spending more, companies will make more money. Wages may go up as well. The economy will grow. This will increase tax income and the government will be able to live within its means by 2020. In turn this will allow Japan to reduce the outrageously high government debt-to-GDP ratio. Frankly, we’re feeling a bit embarrassed about that issue, as people keep asking us awkward questions at cocktail parties! Plus, if we do all this, Japanese exporters will sell more because their products will be more competitively priced in world markets. Other exporting countries won’t mind the extra competition at all. This is because they don’t have any serious economic problems of their own, and because they all love us so much – just look at the number of sushi restaurants around the world! At the same time you may notice a proliferation of pigs flying through Japanese air space from now on.”
Why are the Japanese resorting to ever more desperate money printing schemes? Basically they’ve run out of choices. Government debt is around 230% of GDP, up from 166% in 2004, and still growing. Even with bond yields pinned to the floor (10 year JGBs yield just 0.46%) government income, which is mainly from taxation, only covers 66% of government spending, including interest costs on the debt. The other 36% is funded with new net borrowing.
Household spending was down 5.6% in September, year-on-year, following an increase in sales (consumption) tax from 5% to 8% in April. The plan is to increase the rate to 10% in October 2015, meaning a doubling in total. At the same time inflation adjusted wages fell 3% in the past year. Inflation lingers at 1.2%, below the 2% official target, and is in a downward trend. In the short term oil prices have been falling, which adds to deflationary pressures.
So now it’s all out money debasement or bust. Or maybe it’s bust either way, with or without money debasement. Japan could default on its debt and cause financial mayhem (never a politician’s first choice).
So now it’s all out money debasement or bust. Or maybe it’s bust either way, with or without money debasement. Japan could default on its debt and cause financial mayhem (never a politician’s first choice). Or it can have one last roll of the monetary dice, with the potential outcome being hyperinflation as yen holders eventually panic and engage in wholesale dumping of the currency. Or other countries and regions could decide enough is enough and up the stakes by trying to devalue their own currencies. How long will China, South Korea, the USA or the euro zone countries put up with Japan’s behaviour? Who knows, but we’ll find out soon enough.
This policy in Japan could work. It’s just not likely to. Let’s say they do achieve a balanced budget within a few years, with debt-to-GDP at say 250%. And let’s say they achieve their stated 5% nominal GDP growth (fat chance, but bear with me). Even if all future Japanese governments have the discipline to run a balanced budget, it would still take almost 19 years to get the debt-to-GDP ratio down to 100%, which is still high by normal standards.
Change the debt target to 50% of GDP and we’re talking 33 years to get there – or a whole generation – still assuming that optimistic 5% nominal GDP growth per year.
But then Japan’s population is projected to fall around 2% a year over the next few decades. It peaked in 2011 at 128 million and is now in an accelerating downward trend. So does 5% nominal GDP growth seem likely? I reckon zero growth would be an optimistic outcome as say 2% inflation is netted out with 2% population shrinkage to give 0% nominal annual growth (or -2% real, inflation-adjusted growth).
It’s much more likely that debt will continue to rise, the economy will remain stagnant, and sooner or later there will be a gigantic reckoning day.
Japan’s best case scenario is decades of grinding down the debt to reasonable levels. That will require vast amounts of patience and competence. It’s much more likely that debt will continue to rise, the economy will remain stagnant, and sooner or later there will be a gigantic reckoning day. Crisis beckons, date of arrival unknown. I wish the Japanese all the best of luck for a happy resolution to their problems. I just don’t expect them to achieve it.
On the other side of the planet, Argentina was one of the richest countries in the world in the 19th century. Take any short walk around the centre of its capital city Buenos Aires and you’ll see the magnificent palaces constructed during the 19th and early 20th centuries. They were built as extravagant family homes by the equivalent of today’s billionaires. Nowadays they’re mostly occupied by government ministries, foreign embassies, museums or hotels. Over half a century of political, economic and financial insanity and incompetence have consigned those wealthier days to distant memory.
In the 1980s Japan also had a moment right of the top of the global wealth pile. But more than two decades of complacency and incompetence by policy makers has left it in a deep hole. The supposed solutions are increasingly desperate. One day I expect there to be a monumental financial crisis in Japan. That could provide us with the buying opportunity of the century. But until then the risks and uncertainties are simply too high.
For now Japan keeps digging its way down to Argentina. Until it arrives and realises its mistake there are better places to invest.
Stay tuned OfWealthers,