By Martin Hutchinson
In the month of July, Shinzo Abe won a big victory in Japan’s Upper House elections, which gives him, together with the smaller Komeito party, enough of a majority to rewrite Japan’s constitution.
He has decided, instead, to first attempt to revive the Japanese economy with another “stimulus” program of 10 billion yen ($98 million) in new public spending – a solution that will only worsen Japan’s already-serious debt problem, and ultimately do nothing to revive Japan’s economy.
This “solution” will merely push the country closer to bankruptcy. It’s no longer a question of if, but when.
Falling From Great Heights
The Japanese economy was, for decades, the envy of the world. After a variety of missteps and mishandlings, it’s now in sorry shape.
The producer price index fell 4.2% in the year to June, driven down by the relentless rise in the yen, which is up some 15% against the dollar in the past year. Thus, even with interest rates on 10-year bonds below zero, the economy is suffering high real rates of interest.
Productivity growth is running at minus 2% per annum, and productivity levels are below those of 2007. And with a falling population, without a rise in productivity, it’s impossible for Japan’s output to increase.
Since the financial crisis of 2008, productivity growth has been exceptionally feeble in all countries that have pursued zero-interest rate policies.
Japan has been most aggressive in pursuing these policies, with the Bank of Japan purchasing assets at about $1 trillion a year, three times the size of Ben Bernanke’s purchases at the height of the U.S. “quantitative easing” policy in 2013.
Ultra-low interest rates and artificial “stimulus” of this kind are distorting the capital allocation process in Japan and elsewhere, preventing the normal productivity growth that comes from innovation and optimally allocated resources.
Most dangerously, the Economist’s team of forecasters expects the budget deficit to run at 6.2% of gross domestic product (GDP) in 2016 – and public debt is in excess of 250% of GDP. GDP is not increasing and this is a substantial deficit, meaning that ratio can only spiral upwards.
Only on two occasions in human history has a country’s public debt risen to 250% of GDP without a debt default – both of which were at the end of major wars by Britain.
On the first occasion, in 1815, the debt was worked down by rigorous government austerity – bringing the budget to full balance in only four years after the war ended – and a pro-growth set of economic policies that brought economic growth rates never seen before. This spawned the Industrial Revolution.
The second such occasion occurred in 1945, when Britain brought its debt down by inflating the currency over a 30-year period, impoverishing its middle classes as it did so. Neither of these possibilities appears open to Japan. There simply isn’t an Industrial Revolution awaiting it; Japan’s productivity actually appears to be steadily declining.
And while every government since the late 1990s has attempted to stimulate inflation, Japan’s deflation appears to be getting steadily worse. Default on Japanese government debt thus appears inevitable.
Abe could possibly help this problem by passing labor reforms, freeing up Japan’s sclerotic labor market, but there isn’t much evidence that even this would work – and in any case, Abe’s previous attempt to pass such reforms went nowhere after vested interests opposed it.
His stimulus package initiative of an additional 10 billion yen in government spending could perhaps bring the ultra-high speed train from Tokyo to Osaka forward from 2045 to 2037 – but it won’t do much else.
An extra 2% of GDP in government spending will accrue no benefit for over 20 years, and the cost will only be tacked on to the deficit – already the largest in the wealthy world – under the assumption that it will magically succeed where over 25 years of such Keynesian stimulus plans have utterly failed.
Running Out of Options
Since 1990, Japan has suffered from ever-escalating government spending. Much of which has indulged infrastructure projects favoured by rural areas and large construction companies that are major LDP donors. But Japan already has the world’s best infrastructure, with much higher spending than comparable countries. Clearly, this isn’t the solution to the problem.
In the U.S., Britain, and other Western countries, the solution to the productivity problem is pretty clear: Push interest rates up to “normal” levels – about 2% above the inflation rate – and eliminate the budget deficits that are too high everywhere.
In the short term, this causes a recession. In the long term, it results in resuming productivity growth and slowing debt growth. Ultimately, this puts a country’s economy on the road to healthy growth and a brighter future.
However, this won’t work for Japan. With the economy already in deflation, the scope for interest rate rises is limited. The real need is in balancing the budget, but this is improbable without pushing the economy into deeper recession and escalating Japan’s debt-to-GDP ratio even further. Thus, even with a solid policy, there seems no way to escape Japan’s economic nightmare.
Japan’s debt default is thus inevitable. It remains a question of “when,” not “if.”
The main losers will be Japan’s savers, who bought government debt under the impression that it provides an adequate haven for their retirement. This will spawn a major loss throughout the country and Japan will likely suffer a very deep recession and decline in living standards – similar to the U.S. Great Depression or Argentina’s “infamous decade” in the 1930s.
What a pity for such a beautiful economy and society.
Maynard Keynes has a lot to answer for.
Martin Hutchinson currently publishes a weekly column called The Bear’s Lair, in which he comments on the economy and market. He is also a correspondent for Reuters’ Breaking Views.
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