Friday, May 02, 2014
Japan’s Extraordinary Monetary Experiment
Japan’s economy, the third largest in the world, is in serious trouble. The Bank of Japan (BOJ), the country’s central bank, has embarked on what may well be the most aggressive monetary experiment in history to try to save it.
In this blog, we’ll glance at the grave economic problems confronting Japan and examine the BOJ’s strategy for overcoming them. Let me tell you from the beginning that I believe there is more to the BOJ’s plan than has been announced publicly thus far.
This subject is important because if the BOJ’s strategy works, the rest of the world is likely to adopt it; that would be a game changer.
Let’s start with Japan’s economic problems:
- Japan’s economy has not grown at all in nominal terms since 1993.
- Its population is shrinking. The workforce is expected to contract by 0.6% a year during this decade and by 0.8% a year during the next decade.
- 25% of the population is over 65 years old.
- Japan began experiencing deflation in 1995 and, on an annual basis, prices have fallen more often than not since then.
- After the bubble economy popped in 1990, government deficit spending has prevented the economy from collapsing into depression. The budget deficit has averaged 6% a year since 1993.
- Consequently, the ratio of government debt to GDP has climbed from 60% in 1990 to nearly 250% now.
- To bring the deficit under control, the government increased the “sales tax” form 5% to 8% on April 1st this year. Consumption will decline as a result. That may cause the economy to fall back into recession.
- Japan has traditionally run large trade surpluses. It now has a significant trade deficit. This happened because Japan closed its nuclear power stations after the meltdown of the Fukushima nuclear plant in 2011. It must now import much more oil and gas.
Against this very troubling background, the BOJ launched its extraordinarily aggressive program of fiat money creation at the end of 2012. It announced that it would create about Yen 60 – 70 trillion (the equivalent of roughly $60 -70 billion) a year for two years, thereby doubling the monetary base.
This program is similar to the Fed’s program of Quantitative Easing, but it is three times largerrelative to the size of Japan’s economy than the Fed’s program was (at its peak) relative to the size of the US economy.
The BOJ uses the money it creates to buy Japanese government bonds. By the end of this year, it is expected to own Yen 190 trillion worth of Japanese government bonds or 16% of the total.
The BOJ’s policy clearly boosted Japan’s economy during 2013. The creation of so much fiat money caused the Yen to depreciate by 30% by the end of 2013. The weaker Yen improved the export earnings and profits of Japanese corporations, and thereby fuelled a stock market boom.
The Nikkei rose 60% in 2013. Higher stock prices created a wealth effect, which, combined with some fiscal stimulus last year, brought about a nice pick up in GPD growth, which accelerated to 4% during the first half of the year.
However, this policy appears to have run out of steam. The Yen stopped falling at the beginning of 2014 and the stock market is down 11% so far this year. Moreover, the April sales tax hike will cause a significant economic slowdown. Without further policy action, the economy is going to go right back into the doldrums.
Therefore, I believe the BOJ will soon announce that it will begin printing even more fiat money each month. That should cause the Yen to begin falling again. If so, prices will continue to rise (inflation) and corporate profits will improve further and the stock market rally will resume.
You must be thinking, “This can’t be sustainable. It can’t be possible for a country to print its way to prosperity.” If this were the entire plan, you would be right. But, I believe there is more to this plan than has been announced thus far. I believe that the BOJ will eventually simply write off all the Japanese government bonds that it has acquired. After all, it did not really cost the BOJ anything to buy them. They were purchased with fiat money that the BOJ created from thin air.
If I am right, when the BOJ does write off 30% to 40% of Japan’s government debt, Japan’s economic prospects will be dramatically improved. The amount of interest that the Japanese government has to pay on its debt will fall very sharply and the government will be able to continue stimulating the economy with large budget deficits without risking a fiscal crisis.
I believe this is what the Japanese policymakers are planning to do. It is the best option they have. Moreover, I think it will work.
When it does work, I believe the US Federal Reserve, the Bank of England and the European Central Bank will follow suit and write off the assets they have accumulated with the trillions of dollars worth of fiat money they have created since this crisis began.
If they do, government finances will be greatly improved everywhere and the outlook for our economic future will be much brighter.
DATED: 02.05.2014
FEED: RDPD
