Japan: out of pocket, out of options

               In recent years, discourse on sovereign debt has primarily focused on the Eurozone and- to a lesser extent- the United States of America. Unbeknownst to many, however, a much more severe fiscal crisis has been brewing on the opposite side of the globe. Japan is today the most heavily indebted country on the planet in both absolute and relative terms. With a debt burden equivalent to 240% of G.D.P., and a debt-servicing burden that takes up more than 25% of all public spending, Japan’s number is clearly up. Japan has been enmeshed in economic dislocation for a quarter century; every attempt to jumpstart the economy has been fair-to-middling in success. Every Japanese citizen now owes in excess of $100,000. To put this into context, if a sum equivalent to Japan’s public debt was divided evenly among Kenya’s 44 million people, each one of us would receive close to sh. 26,000,000. But how did Japan get here? How did Japan go from superpower in waiting to the emblem of fiscal profligacy? How did a people with a global reputation for thrift end up owing more than twice their annual income?

              Japan came out of the Second World War crushed and at the end of its resources. But it somehow crawled from the ashes of war and in the decades that followed, Japan staged one of the most spectacular cases of economic expansion in modern history. Between 1960 and 1990, Japan’s per capita income swelled from about $7000 to upwards of $30,000. But the Japanese economic miracle run its course in the early 1990’s after a massive stock and real estate bubble exploded, beginning a period of economic sclerosis that persists to the present day.

Boom and Bust

               Japan’s perils can be traced back to Plaza Accord of 1985. The Accord- signed by Britain, France, Japan, West Germany, and the United states- was actuated to arrest the dollar’s appreciation on the international foreign exchange markets. Subsequent to the Accord, the Dollar/Yen exchange rate fell sharply, playing havoc with Japanese exports. The Bank of Japan responded by lowering interest rates: cutting its discount rate in half between January 1986 and February 1987. The ensuing credit expansion augmented one of the most spectacular economic booms in history. The Japanese stock market put on an unprecedented rally: the Nikkei Stock index almost quadrupled between 1985 and 1989. At its peak, the Japanese stock market accounted for 42% of the planet’s market capitalization. Japanese Real Estate also saw a rally that, with hindsight, is almost comical. Famously, the land on which the Imperial palace stands was believed to be worth more than the entire state of California. The boom- like all credit-induced booms go- was dependent on the continuous injection of cheap credit into the economy by the BoJ. As Austrian Business Cycle Theory would predict, when the BoJ began raising rates- taking them all the way to 6% in 1989- Japan imploded. The Nikkei index crashed by more than 60% by 1992; real estate prices fell 80% between 1991 and 1998. In some districts, real estate is only worth 1% of the price printed at the peak of the bubble.

              Predictably, the Japanese government responded by trying to stimulate the economy. Instead of allowing the liquidation of the unsustainable projects initiated in the boom phase, the Japanese government has done everything to prevent the necessary realignment of production with consumer preferences. Although Paul Krugman would implore you to believe that Japan has not carried out enough stimulus, it has in fact thrown trillions of yen at the recession over the last two decades. Foremost among its ‘recovery’ efforts has been the Keynesian nostrum of government spending to boost ‘aggregate demand’. In the course of the 1990’s, Japan implemented ten fiscal stimulus packages amounting to 100 trillion yen- all of which failed to deliver the country’s economy from malaise.

               The Japanese government has also gone to great expense to provide credit to businesses that are unproductive and technically bankrupt. Instead of allowing these businesses to fail, the Japanese government- not unlike its American counterpart- has implemented bailout and price support programs that only serve to impede the capital reallocation necessary for recovery. In 1998, the government established a $514 billion bailout fund, of which more than half went on purchasing stock in the banking industry. The government also routinely supports the real estate and stock markets, stepping in to prop the latter whenever the Nikkei falls below 12,000. Japan has forked out at least 20 trillion yen in loans to troubled companies, many of which are of questionable credit. Because of this policy of propping frothy, overbought markets, the Japanese government now holds a real estate and stock portfolio worth more than 7 trillion yen.

              As submitted earlier, Japan’s efforts to push-start the economy have been unsuccessful by any standard. In spite of the trillions spent on fiscal stimulus in the 1990’s, for example, real GDP was a paltry 40.6 billion yen higher in 2000 than in 1990. After 1998, Japan experienced several years of negative growth.

Abenomics

               The election of current Prime Minister Shinzo Abe in 2012 may with hindsight come to be seen as Japan’s coup de grace. With his famed ‘Three arrows’ in hand, Shinzo swept into office convinced that Japan’s remedy was inflation. If only he could make things more expensive every year, all would be hunky-dory. To that end, Abe’s administration unleashed an assault on the yen that has sent the currency into a sharp nosedive. Early in 2013, the Bank of Japan announced a monetary stimulus campaign that would see the Bank of Japan purchase 60-70 trillion yen in assets ‘for at least two years’. The unprecedented campaign was aimed at weakening the yen, creating inflation (Abe’s target was 2% on a yearly basis), and therefore- according to Keynesian lore- boosting aggregate demand and exports.

               As those of us not indoctrinated into the Keynesian superstitions expected, the money printing binge did not restart Japan’s economy. Sure the yen has fallen more than 35% against the dollar since Abe came on the scene, the Nikkei 225 has climbed more than 60% and after years of negative inflation, inflation in Japan is now north of Abe’s 2% target. But has this delivered Japan from economic stagnation? Quite the opposite: for the first time in decades Japan is registering trade deficits, real wages are falling, and the Japanese economy contracted by a whopping 7.1% (YoY) in the second quarter of 2014 and 1.6% (YoY) in the third. It seems Abe aimed his arrows at the wrong target. Mainstream economists- adding to a record that is already extremely embarrassing- logged this as the result of tax hikes. According to the polylogism of mainstream economics, price increases resulting from currency debasement induce spending, while price increases resulting from tax rate hikes cause spending to slow.  

The Road to Zimbabwe

               What the Bank of Japan learned from this catastrophe was that more money printing was needed. Accordingly, on October 31, 2014, the bank announced an expansion of its asset purchase program by $800 billion. This immediately sent Japanese government bond yields and the yen into a tailspin. The Bank of Japan is now practically the sole buyer of Japanese bonds- shades of Zimbabwe!

Japan is the most heavily indebted nation on earth, with a debt that surpassed a quadrillion yen in 2013. 59% of the country’s tax revenue went for servicing their monolithic debt in 2010. The only reason Japan has avoided a default is the BoJ’s interest rate manipulation. Although inflation in Japan is now running as high as 3.7%, yields on five-year and ten-year bonds stand at 0.02% and 0.29% respectively. This is lunacy. Haruhiko Kuroda believes that he can keep debt-servicing costs this low indefinitely. However, as Japan’s debt piles, he will need to print ever greater amounts of yen to purchase ever greater volumes of new debt. The BoJ has painted itself into a wall: it is now totally powerless to arrest the yen’s decline.

               Barring a miracle, the crash of the Japanese yen and the Japanese bond market are inevitable. The snake oil of Abenomics has been a catastrophic failure, and I see no reason to expect its fortunes to reverse in the future. Although it is highly implausible, the intentions of Shinzo Abe and Haruhiko Kuroda may be good. But as somebody said, the road to Zimbabwe is paved with good intentions. The only thing separating Japan from full-bore economic crisis is time. And there isn’t much of it left.