In memory of Dr. Andreas Höfert

Japan: new laboratory of crazy economics

Japan isn’t doing well. In 2013 it will be undergoing its 22nd year of deflation/stagnation/recession since its twin real estate and stock market bubbles burst at the beginning of the 1990s. Its real gross domestic product was roughly 10% lower at the end of 2012 than it was 15 years ago. Also noteworthy, as a reflection of this dismal economic environment for investors, is that, added together, the market capitalizations of the four largest Japanese technology firms - Panasonic, Toshiba, Sony and Fujitsu - don’t currently equal that of Samsung, Korea’s leading tech company.

Japan isn’t doing well. Its public debt corresponds now to almost 240% of GDP - a percentage twice as large as Italy’s. Moreover, even though its current account balance remains positive for now, its trade balance has been in the red for more than two years, not least because of the Japanese yen, which despite its recent correction continues to be significantly overvalued.

Hence, it goes without saying that Western leaders and central bankers fear that their own economies, still recuperating from the financial crisis of 2007-08, could follow a path similar to Japan’s. Quite presciently, US Federal Reserve Chairman Ben Bernanke laid out his program 10 years ago to ensure that Japanese-like deflation “never happens here.” It can be summarized as “print as much money as you can,” because according to Bernanke in 2002 “under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.”

This program is the one that the Fed has been applying for some time now, the one that will lead, after several consecutive “quantitative easing” measures, to a quadrupling of the US monetary base by September 2013 compared with its level of September 2008, the one that is financing en passant a non-negligible part of the US public deficit.

Oddly enough, the Bank of Japan has thus far been reluctant to apply the Fed chairman’s program, but this is about to change. Newly elected Japanese Prime Minister Shinzo Abe recently announced some spectacular measures. The Bank of Japan (BoJ) is to increase its inflation target from 1% to 2% and use unlimited means (or “whatever it takes” in European Central Bank-speak) to achieve this goal. If the BoJ, which is de jure independent, refuses to do so then its independence will be revoked, Abe said. His threat underscores the more general fact that, whatever its institutional framework might be, a central bank is de facto never completely independent.

Even before Abe issued his threat it was clear that the current asset purchase program the BoJ has embarked upon is sufficient to finance the whole Japanese public deficit for 2013. According to Nikkei News it seems that part of this program will also be used to buy participations in industrial companies, forcing them to invest more. The first results of these brute-force policy announcements are already in. Since Abe was elected, the yen has started to fall and the Japanese stock market to rise.

The case of Japan will be very interesting to follow during 2013 and beyond. Either Abe succeeds, which would bode well for the monetary policy being pursued by most Western central banks. Or, as seems more likely to me, he fails and uncontrolled inflation ensues ineluctably in Japan, and serves as a preview of what will befall us in the West sometime later.