Japan’s Crisis & The BOJ’s Solution
Posted November 24, 2014
In the latest Macro Watch video (uploaded today) we look at Japan and the very serious challenges it faces. These include a demographic crisis, a sharp deterioration in its trade balance, deflationary pressures and a dangerously high level of government debt relative to GDP. We also consider how the Japanese government is responding to those challenges and what that is likely to mean for the Yen and the Japanese stock market going forward.
There is a discussion of how the Bank of Japan’s Quantitative and Qualitative Easing program works and why it is fundamentally flawed – at least in its current form. The BOJ now owns 24% of all Japanese government debt. I believe they will eventually write that debt off, thereby, radically improving the outlook for Japan’s economy. I hope you will watch this video and let me know if you agree.
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I just watched your MacroWatch video on Japan’s crisis, but have been left a bit confused. What seems to be the real issue there? I notice that the GDP is about the same level that it was in 1992, but the population is also about the same level, and the workforce is slightly above that, even with the aging population getting older. So why is there a push for GDP growth and inflation? Is it growth for growth sake?
I can understand that there is a valid desire to avoid the 1930’s type of depression (my father and mother went through that time period, so I know how bad it can be). But wouldn’t it be better to look at easing the economy back to a “natural level”, i.e. continued deflation? I remember from one of your courses that you somewhat “justify” inflation based on expectations by lenders, but isn’t the reality that just as lenders increase interest rates to account for inflation, they can similarly adjust interest rates to adjust for deflation (though not below zero). This should also point to the problem of the Japanese saver. Isn’t the Japanese saver is more focused on the government debt than on traditional savings? Just as the lenders wouldn’t want to adjust for deflation below zero, the Japanese saver would also not want to save with adjusted interest rates below zero (for example, that is the philosophy behind ECB).
I hope you can clear some of this up for me.
Thanks for the questions.
Yes, the GDP is about the same now as in 1992, but that is because the government has been running very large budget deficits every year. Without that government spending, the economy would have collapsed into a depression. Now that the ratio of government debt to GDP is almost 250%, the government cannot afford to keep running such large budget deficits forever. Without economic growth, it will be hard to bring the budget deficits down, much less ever reduce the government debt.
Also, without economic growth, it will be difficult for Japan to provide/care for its rapidly ageing population.
Furthermore, if Japan’s economy ceases to grow, then it will soon fall behind China. Over time, Japan would become increasingly weak relative to all its neighbours – and, therefore, increasingly vulnerable to aggression.
In a competitive world, countries need to grow economically to survive.
Thank you for your reply. I still don’t think I am convinced. In a competitive world, I think technological advance would be more important than simply growth in the GDP. That takes investment and flexibility in the labor force. This most likely would involve growth, but more importantly would be a shift in the economical structure.
Honestly, I haven’t thought through this thoroughly, but I can’t see that simply pushing up asset values is a solution in a country that already has a high savings rate would do to much to help this economy. Increasing asset values works if it induces consumption (and then only for a short time until the bubble bursts).
These are good series that you produce. I always look forward to the next.
What I find interesting is that QQE was first announced in April 2013, just as the Yen was bottoming at 100, and then proceeded to trade sideways for a year and a half, before starting its recent plunge in August 2014.
I’m not disagreeing with Richard, but merely observing how market participants move markets in such a disjointed way relative to fundamentals.
Richard states that there are risks on relying on continued Yen depreciation and risk for reversal if QE4 is announced, but I could imagine a scenario where the Yen collapse continues for some time despite this. QE4 would show Fed desperation for sure, but compared to what? The ECB and BoJ are in deeper, more immediate trouble than the Fed.
So all central banks will simply wright off all the sovereign debt on their books without consequences? Is that really the case?
I can see how this solves the excess debt problem of may countries, but if it was that easy, why haven’t they done it already.
Regarding John’s comment above, the Yen was about 80 in December 2012. It then started depreciating sharply as the market came to realize that Abe would be elected PM and that he was likely to force the BOJ to adopt aggressive QE.
Regarding kmoller’s question “why haven’t they done it already”, there is no rush for the central banks to write off the government debt they have acquired though QE. As things are now, the government(s) pay interest on those bonds to the central banks, but the central banks just give their profits (from the interest they earn on those bonds) back to the governments anyway. For example, the Fed has been handing over about $90 billion of its profits a year to the US Treasury Department for several years now. That has reduced the budget deficit by that amount each year. So, really, there’s not much difference between the current situation and writing off the government debt. But it would create a positive psychological impact if (when) the central banks write off that debt. They can keep that trick up their sleeve for later, for a future crisis.
This doesn’t make any sense to me. Someone has to suffer if central banks around the world simply write off the debt. How can our problems be solved that easily. What message would this send, don’t worry about going into debt, will just write it off. What kind of system is that. If it were that simple and of no consequence then building up debt wouldn’t
be a concern. I don’t get it.
Based on everything we have been taught about economics, you are right, central banks printing money, buying government debt and then writing it off should not work. However, I believe our economy has changed. That’s why I call my blog “Economics In The Age Of Fiat Money”. One of the most important changes is that, because of globalization, we now have, for all particle purposes, an infinitely large labor force willing to work for very low wages. Two billion people live on less than three dollars a day. Therefore, inflation is not a threat (for the near term, anyway)
Let’s use the US as an example. In the past, before globalization, if the US government ran very large budget deficits and the Fed printed money on a very large scale and used it to buy the government debt (issued to fund the deficits), then that would have very quickly overstimulated the US economy, resulting in the full employment of labor and full capacity utilisation; and that would have resulted in a surge in inflation. Something like that (but on a smaller scale than during the last few years) happened during the 1960s, when the US spent too much on Vietnam and Johnson’s Great Society programs. So, the US ended up with double-digit inflation in the 1970s. At that time, because of the constraints of the Bretton Woods System, the US could not run a large trade deficit. So, when all the domestic labor and capacity was employed, prices rose and led to the high rates of inflation in the 1970s. This was very typical of how things worked before we stopped backing dollars with gold in 1968.
So, back then, large government budget deficits and, especially, central bank money printing on a large scale was TABOO. No one could have even imagined a situation where the Fed had printed $3.5 trillion and used it to buy government bonds (and Fannie and Freddie bonds). So, no one ever discussed what the consequences of the Fed writing off those assets would be. The TABOO was printing money and buying the assets in the first place.
Well, that taboo has already been violated. The money has been printed and the assets have been acquired. And, it has not caused inflation. Why? Because we now have an infinite supply of very cheap labor. And because we have a great deal of excess capacity across all industries globally (which came into existance due to the explosion of credit that has occurred during the decades since we broke the link between money and gold).
So, in other words, we are living in a situation that no prior generation has experience before – one where central banks can finance massive amounts of government deficit spending by printing trillions of dollars without creating hyperinflation. We need to understand this and make the most of it!
It did not cost the Fed (or the BOJ or the BOE or the ECB) anything to print the money (they used to buy the bonds). So, they won’t be any worse off if they write it all off. I think they eventually will write it off. But, to a considerable extent, as long as they hold on to the government debt, it really does not matter if they write it off or not. The government pays interest on the bonds to the central bank (which the central bank records as profits). The central bank then takes all its profits and gives it to the government, thereby completely offsetting the interest the government paid on those bonds owned by the central bank. So, the only real advantage of actually writing it off would be that it would make the government’s debt to GDP ratio lower.
Personally, I think this is a once-in-history opportunity that we should fully exploit. I would like to see the US government increase its budget deficit over the next 10 years by investing very aggressively in new industries and technologies (like biotech, genetic engineering, nano tech, solar, etc.). The Fed could finance much of that by printing money (so long as inflation does not pick up and, if it does begin to pick up, they could stop). Meanwhile, that kind of investment would induce a new technological revolution that would not only lock in another American Century, but also improve the wellbeing of everyone on this planet. The government could either invest the money directly (as it did with NASA and as it does with the military) or it could act as a venture capital company, raising the money (from the Fed) and allocating it to the most promising 10,000 American entrepreneurs, through joint venture companies in which the government would retain the majority of the equity (which would generate trillions of dollars of profit for the government, perhaps allowing it to abolish the income tax, for instance).
This window of opportunity won’t last forever, but we should make the most of it while it does! We have to understand the age we live in and not be controlled by the teachings of economists who lived in a different age.
Central Banks create money out of thin air to purchase government bonds to finance deficit spending. The deficit can come from the government spending “too much” or not taxing “enough”. If we eliminated the payroll tax for a few years, individuals could pay down their debt and spend money into the economy. This would result in a wider deficit but this deficit is financed by printing money. If it’s not overly inflationary, this should be done.
As Richard has pointed out, the Fed has already printed $4 Trillion. It has not caused inflation. Why should the American people work really hard to pay the Central Bank back? The Central back will just take that money and “incinerate” it. It makes a lot more sense to use those $s to build out US infrastructure than to send it to the Fed and have them vaporize it. Again, as long as the currency doesn’t drop into an inflationary free fall, QE should continue and the debt should be written off by the Fed. That would end the excess debt problems for both individuals and government.
All money does is allocate labor and resources. Currently we have labor resources that we are not utilizing…generally paying them a small amount to sit idle. We should be taking our slack labor resources and applying them to build out our crumbling infrastructure. Some want us to wait for better times until we can afford it. In effect, when times are good the Govt would need to compete with the private sector for labor and thus drive up the price and causing inflation. Now is the time we should be taking our slack labor to build out infrastructure.
Many say we can’t afford it and that our children will owe the Fed to much money. If continue on the cut the deficit theme….fast forward 20/30 years and our infrastructure has crumbled, our children are uneducated and will now have take care of the boomer generation. Instead, I would advocate, we build out our infrastructure, educate and employ our children and have the Fed pay for much of it. In 20/30 years, we will have world class infrastructure and the younger generation will be able to support the retired boomers. Oh and the Fed can forgive the debt built up during that time.
But some say this will cause too much inflation. if it does then you’d have to eliminate QE. The evidence is in and so far, it hasn’t caused too much inflation for us or for Japan.
Sacrificing our hard earned dollars acquired thru labor to the Fed is akin to the Aztecs sacrificing people to the Sun god. It’s really not necessary.
Richard, this is my view and I think you may share it but if not, please clarify. Thanks.
Yes. I do agree with you. Please see my long reply to Mark’s comment below.
I understand the logic and the data behind the scenario you laid out. But I think that there is one fallacy here. That is the malinvestment that this creates. As you mention, the developed nations can continue to print money and through deficit spending, invest in either infrastructure or technology projects or perhaps both for the betterment of their people. But as you also mention, there is a good deal of overcapacity which has already been created. And I presume that that overcapacity is sitting in the developing and emerging markets. They are experiencing the difficult fluctuations that come from the rapid expansion and subsequent slow down. And I would guess that they are also trying to keep their economies from rapid inflation.
I may be wrong, but I cannot imagine that the printing of so much money by all these developed nations can be done without negative consequences. There has to be inflation somewhere.
Your analysis is certainly thought provoking. I find it hard to accept that we can print our way to prosperity. I agree that if we are going to print the money lets put it to good use in the way you suggest. The problem is that isn’t how the money is being spent. Instead, the money either isn’t getting to the people at all or it’s being used for social and welfare programs that aren’t producing or building anything. Unfortunately, at this point, I see no chance of the income tax being abolished in mine or my children’s life time. On the contrary, I see our taxes getting higher, not lower. Thank you for your responses.
In reply to Jeronimo’s comment that “There has to be inflation somewhere”, the inflation has been in asset prices.
I see a lot of similarity between Richard’s proposals and the economist Mariana Mazzucato’s. https://marianamazzucato.com/ . Her research is in the economics around innovation and the role of the state. I think, what she says is that it is actually the state that is responsible for much of the innovation that occurs, that the mainstream idea of state being a hindrance to private sector innovation is wrong. Taking Apple’s ‘innovative’ smartphones as an example, the GPS, chip and screen technology is all the result of decades of government led research. One of her proposals to bridge this state-private divide , is an alternative to government taxation : direct profit rewards for technology and services brought to the private sector, removing the need for taxation while allowing the state to address inequality that currently results from unfair concentration of wealth.
Getting all these ideas implemented will need getting the corporate executives on board. I interpret Richard’s proposals as being about state-funded global structural reform, but the network of large Corporates *is* the structure that would be reformed. It is not in the Corporate nature to be controlled.
There are others working in the same area I think: William Lazonick and James Galbraith for example. Richard’s (and Mariana’s etc) proposals make perfect sense to me, and I think if they were implemented the future would be spectacularly bright. But how to organize it all and then bring a proposal politically acceptable to both the state and corporate leadership?
Thank you very much for bringing Mariana Mazzucato to my attention. I looked at her website and watched her Ted Talk last night. I was very impressed. I hope everyone reading this will take a few minutes to watch her Ted Talk. As a society, it’s very important that we understand that the structure of our economy is very different now than it was before the World Wars. The government now plays a leading role. No matter how you feel about that fact, it’s not going to change. So, the better we understand what the government is doing, the sooner we may find a way to make it work better for everyone.
Hi Richard I just finished reading your book ‘The dollar Crisis’ I found it very insightful well researched and drew the proper conclusions to the upcoming correction in the U.S account deficit. I do not however agree with your assertion that gold cannot function as the global money supply. Though the supply of Gold and for that matter Silver as well are somewhat erratic in that they are mined and therefore sometimes production is greater and sometimes weaker. This minor inconvenience seems far more favorable than a global central bank running amok on a global level. As long as dollars are tied to nothing of tangible value the temptation to print more money than is needed, which benefits some far more than others, will always be a problem. That along with a central bankers inevitable bias regarding personal ideologies prejudices etc. Just look at the dysfunction in the united nations as an example.
As for the limited supply of gold, global reserves of gold and silver have more than doubled in the last 100 years compared to all the gold and silver mined before that time in all of history. And if demand stays high I see no reason why that trend would not continue. To me gold and silver seem like the natural and perfect money for the global financial system, with all the inherent safeguards regarding trade imbalances naturally built in. And a strong history as money for thousands of years. like even Allen Greenspan said “we did extremely well” without a central bank and with a gold standard.”
I see the solution to many of the global economic problems in less centralization and more in decentralization. In smaller scale grassroots enterprises, new types of business and organizations built up by enterprising individuals less reliant on govt. fixes and more reliant on personal freedoms and local solutions to issues. Instead of more govt. be that on a national or international level.
Since the end of the Brenton Woods system the global economy has been nothing less than a con game, with some benefiting enormously and others footing the bill. Personally I can’t see a system of global minimum wage etc. working, it would be to complicated and costly to enforce and too easy to cheat. Along with all the dangers of overbearing bureaucracy and despotism inherent in any overly centralized system. Personally I think that only when gold and silver begin to reassert their role as sound money will the problems of excess liquidity, willy nilly credit creation and govt. largess be solved.
Sorry but I digress. The way to make society work better for everyone is to have sound money. something no fiat system can ever achieve. Central banks are scared of gold as well they should be. Because when, not if, gold swamps all the paper currencies the international con game is up. Took a look at what GATA ( Gold Anti Trust Action Committee) has been doing and the fraud perpetrated against the free markets in precious metals. It aint over until the fat lady sings and in this case the sound of that fat Lady is going to be the collapse of the bloated fiat monetary system.
Again Alan Greenspan said it quite well..
“An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense — perhaps more clearly and subtly than many consistent defenders of laissez-faire — that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.”