On December 16, 2012, Japan elected a new party, Liberal Democratic Party (LDP), to power. It’s not really a new party, as the LDP governed nearly uninterrupted from 1958 to 2009. At that time, widespread discontent over the stagnant Japanese economy spurred a change in control, in which the more liberal Democratic Party (DP) took power. Importantly, similar to the situation in 2009, the vote today reflected widespread dissatisfaction with the outgoing party rather than an enthusiastic public endorsement of new victor’s policies.
The Japanese election is not the event that I find of such great significance. Polls have indicated for weeks that the conservatives were about to win an overwhelming majority, and the results of today’s election come as no surprise. The “event of 2013” is about to come . . . .
The leader of the LDP, Mr Shinzo Abe, has recently advocated a plan to spur economic growth and stop the multi-year deflation that has gripped Japan. Mr Abe states that he will pare back the independence of the Bank of Japan (Japan’s central Bank, which is Japan’s counterpart to the US’ Federal Reserve). Once the BOJ is subordinate to the government, Mr Abe will direct the BOJ to print money to fund Japanese construction and public works programs.
At this point, one must step back and observe that central banks across the globe are printing money. They are buying government bonds with the goals of:
- Injecting money into the economy
- Reducing interest rates
- Raising asset prices (to create a ‘wealth effect’ and thereby increase consumer confidence and consumer spending)
- Increase inflation (Generating the ‘right amount’ of inflation is tricky and lofty goal. Inflation is a redistribution of wealth. It lowers the real value of debt burdens while also eroding the value of any money amassed by savers. Those with debt may benefit, as may those close to capital who can see inflation early and react. The middle class is fully susceptible to being hurt by inflation.)
I believe that the BOJ’s plan is materially different from anything yet undertaken by other central banks for two reasons:
First, Mr Abe will essentially seize control of the BOJ. While the BOJ might retain some independence, it is illusory. Any independence is either because the Japanese government is comfortable with the ‘independent’ policies or because the government is experimenting with one policy at a time. Once partial control is usurped, any independent policy of the BOJ is a mere whim away from being seized by the government. All other central banks are maintaining their independence. Their policies, while similar in nature thus far, are being stewarded by independent economists, not by politicians. This is important, as the latter are both less savvy/economically educated and, more importantly, less motivated to enact sure-term measures that pander to the populace (with the hopes of increasing their chances in near term elections) but that contain enormous long-term consequences.
Second, and critically, Mr Abe’s language suggests to me that he will accelerate his program of money printing until the Japanese economy reaches his target for inflation (in this case, 2%). As I interpret the situation, this stands in contrast to other central bank actions that are not only more measured, but where the goals are more nebulous and generally centered around preserving economic stability.
In a nutshell, I believe there is the potential for Japan to undertake an unprecedentedly aggressive policy of printing money. Politicians are notorious for backtracking, so it is possible, now that he’s been elected, that Mr Abe backs off from his campaign promises. I don’t think he will back off though. As a result, we are about to see one of the greatest economic experiments ever conducted.
To emphasize the point, quantitative easing has very respectable proponents and detractors. If Japan undertakes the program that Mr Abe has outlined, it will be quantitative easing that eclipses all other programs across the globe. It will be taken to the extreme. We may, in short order, see the effects of this policy play out. Perhaps they will be good. Perhaps not. Whatever the outcome, the results of this experiment are likely to inform economists/central bankers and shape central banking policy across the globe.
Having said this, I’ll take a moment to consider the two extreme scenarios.
- The world believes that Mr Abe will engage in printing Yen. The value of the Yen declines such that Japanese products are inexpensive to the rest of the world. Exports increase.
- At the same time, consumers believe their money will be less valuable in the future. They begin to spend their savings to purchase goods while prices are still low. Such spending increases corporate output, leading to hiring and new jobs.
- Higher corporate profits lead to investment in new production capacity. Higher employment results in more consumers. A virtuous cycle ensues.
- Japan begins prints money and engages in construction products that have little real economic value. Jobs are temporarily created, but this transfer of money to a few select workers results in even higher Japanese debt without producing any good for Japanese tax-payers in general.
- The value of the Yen declines. Incremental increases in exports pale in comparison to the higher costs of food and fuel.
- The increasingly elderly population sees their savings eroded. They, along with the Japanese population at large, spend more money on necessities (now more expensive) and there is actually less household money available for discretionary spending.
- As inflation expectations increase, and as the value of the Yen falls, buyers of Japanese Government Bonds demand higher yields. With debt to GDP of approximately 220%, increasing interest rates from less than 1% currently to 3% would consume an incremental 4-5% of Japan’s total GDP in interest payments
- If interest rates increase and Japan bonds fall in price, Japanese banks may suffer. Banks often borrow at short-term rates and lend at longer-term rates (buying government bonds, for example). Losses on such bonds could endanger banks (and savings/deposits by extension) leading to a banking crisis.
I have tried to play the scenarios forward. There are too many permutations to have any confidence in the outcome. Even so, the magnitude of the experiment merits very close observation. If successful, this may be a road map for more aggressive central banking actions across the globe.
If unsuccessful, it could precipitate a devastating crisis in Japan. If that happens, I would think the world could see a repeat of what happened in the 1997 Asian currency crisis. At that time, Thailand suffered a collapse of their currency, the Baht. Economists initially believed that Thailand was isolated, and the stress would be contained only to Thailand. However, ‘the market’ began to look to countries that could face similar stresses, and the crisis spread. In the current situation, Japan has many similarities to Spain, Italy, France, Germany, the US, etc. A crisis in Japan is unlikely to be contained.
As I said, perhaps Mr Abe will backtrack on his campaign promises and the experiment will not be conducted. If, however, Mr Abe presses forward, Japan should be watched with the highest level of scrutiny. I believe that this single experiment could instruct and/or impact the central banks and the economic future of the world for years to come. The enormity of this experiment can not be emphasized enough.