Japan’s economy and stock market have gone from being incredibly dull to being remarkably interesting almost overnight. A new government has been elected on the promise to jolt the economy back to life with a massive dose of fiscal and monetary stimulus – even if it has to take away the independence of the Japanese central bank to do so. As a result, the Yen is falling, the global competitiveness of Japanese industry is improving and the stock market is rallying strongly.
These developments are not only of interest in and of themselves, but they are also important for what they tell us about the prospects and possibilities for the US economy during the years ahead.
Here’s what’s happened. On December 16th, under the leadership of Shinzo Abe, the Liberal Democratic Party (LDP) and its small ally, the New Komeito Party, won a two-thirds majority in the lower house of Parliament. Abe and his party had campaigned on the promise to reinvigorate Japan’s economy with aggressive government spending and monetary expansion. Now that he has become Prime Minister, he has made it clear that he will waste no time in implementing those policies. In response, the Yen has fallen by nearly 8% and the stock market has risen by 10% since the elections were announced in November.
Japan’s economy has been in crisis since its economic bubble popped in 1990. Its GDP has barely grown at all since then (if not adjusted for deflation). The situation would have been far worse – Japan would have collapsed into a depression – had the government not propped up the economy with large government budget deficits practically every year since the crisis began. Because of those deficits, the ratio of government debt to GDP has risen from 60% of GDP in 1990 to approximately 240% now. To put that figure into perspective, the ratio of US government debt to GDP is now approximately 100% of US GDP.
The challenges confronting Japan are formidable. The country’s population is not only aging, it is also shrinking. Its high wage structure makes it difficult for Japanese industry to compete globally with China and other low wage countries. Japan’s banking industry remains impaired with non-performing loans from the bubble era. Property prices remain too high relative to the income of the public. The weak global economy means demand for Japanese exports is falling. Furthermore, the economy remains dependent on government deficit spending. The budget deficit for 2012 is estimated to be 10% of GDP. And even with so much deficit spending the economy is believed to have fallen back into recession during the second half of the year. There appears to be no end in sight for Japan’s economic crisis.
Perhaps, then, it was out of desperation that the Japanese electorate voted so overwhelmingly in favor of Abe and his plan to revive the economy with yet more fiscal and monetary stimulus.
The Prime Minister’s economic policy has two planks. The first is to force Japan’s central bank, the Bank of Japan (BOJ), to print more money. Japan has been experiencing deflation off and on for two decades. To put an end to deflation, Abe has demanded that the BOJ expand the money supply (by printing Yen from thin air) until the inflation rate reaches 2%. Moreover, he has threatened to change the law and remove the BOJ’s political independence if it refuses to meet his demands.
The BOJ is already conducting a money-printing “Quantitative Easing” program, but it is not aggressive enough for Abe because it has not yet put an end to deflation.
Abe believes that printing more Yen will benefit Japan in a number of ways. First, it will put downward pressure on the value of the Yen; and a lower Yen will improve the competitiveness of Japanese exporters in the global marketplace. Next, when the BOJ prints money, it uses that money to buy government bonds. That pushes up the price of the bonds, causing their yields to decline. Low yields allow the government to borrow money at more affordable rates. Incredibly, despite the government’s massive debt and large annual deficits, the interest rate on 10-year government bonds is only 77 basis points or 0.77% (versus 1.7% in the US). There is also some possibility that the BOJ will buy stocks. It has done so before. If it does, it will push stock prices higher and create a wealth effect that will support economic growth.
The second part of Prime Minister Abe’s economic plan involves increased government spending. The exact amount has not yet been announced. However, Abe has instructed Japan’s finance minister to ignore the ceiling on the annual debt issuance that had been put into place by the previous government. Responding to criticism that in the past too much government stimulus money had been spent “building bridges to nowhere” just to provide jobs, Abe has stated that this time the money will be employed in “a growth strategy that encourages private investment.”
No one should doubt that Abe’s stimulus plan will boost economic growth in the short term. Currency devaluation and government deficit spending will always boost short-term growth. What is uncertain is the long-term consequences of paper money creation and unprecedented levels of government debt. One real danger is that the interest rates on government bonds rise sharply as a result of these policies. Significantly higher interest rates could make it difficult – or impossible – for the government to finance the interest expense on so much government debt. Thus far, globalization and competition from low wage countries continue to exert strong deflationary pressure in Japan. These deflationary pressures have kept interest rates low. However, if the BOJ were to achieve Abe’s 2% inflation target, it is certain that government bond yields would rise in response. Abe should therefore be careful what he wishes for.
Japan is entering its 23rd year of economic crisis. It has already wasted an enormous amount of time and money “building bridges to nowhere” to generate short-term growth. It will be interesting to see if this time really is different, to see if the money is spent in a manner that does begin to generate sustainable growth. It will also be interesting to see how much government debt Japan can accumulate before a fiscal crisis erupts. Will it be at a ratio of 250% of GDP, or something closer to 450%? Only time will tell.
Meanwhile, however, there are many important lessons the United States should learn from Japan’s multi-decade crisis and its recent decision to undertake yet another massive round of fiscal and monetary stimulus. The first is that it is very difficult for a post-bubble developed economy with a high wage structure to compete globally and generate economic growth without government stimulus.
The second lesson is that it is possible for such a country to run up government debt equivalent to (at least) 240% of GDP without provoking a fiscal crisis.
Third, the interest rates on government bonds in a post-bubble developed economy can remain extremely low despite unprecedented levels of government debt and very high annual budget deficits.
The fourth lesson for America is that a democratic society will not tolerate government austerity and recession under the above conditions, but instead will continue to vote for political parties that promise to create growth through government stimulus.
If the United Sates understands these lessons it will see that the US will follow Japan’s path of piling up more and more government debt over the next couple of decades. That is inevitable. Where the US does have a choice is on how the government will spend that money. The choices lie between spending government money randomly building bridges to nowhere and on new wars or else on spending the money based on a rational plan of investment designed to restructure the country’s credit-deformed economic structure and restore its economic greatness. The United States could increase its government debt by well over $22 trillion (from $16 trillion currently to $34 trillion) before it hit the level of government debt to GDP that Japan has today.
Japan’s post-bubble experience and the recent decision of the Japanese public to vote for still more government spending and monetary expansion highlights the absurdity of the current political convulsions in Washington surrounding how to avoid the self-inflicted economic calamity that will slam into the United States in 2013 if the fiscal cliff is not avoided. Members of Congress should learn from the experience of their counterparts in Japan. If they try to cut government spending, the economy will fall back into recession and they will be voted out of office and replaced by politicians who will spend more government money to stimulate the economy.
Congress and the American public need to understand that the United States government will continue to run enormous budget deficits to prevent the economy from collapsing into depression. We must decide how that money will be spent. Our options are to continue wasting the money on excessive consumption and war or to invest it in 21st Century technologies and industries so as to restructure and revitalize our economy. The first option will ultimately lead to ruin. The second option will produce many decades of increasing prosperity. This message is developed at much greater length in my most recent book, The New Depression: The Breakdown Of The Paper Money Economy.