Some market commentators have likened Japanese Prime Minister Abe’s recent economic reforms to rearranging deck chairs on the Titanic. I think the analogy is not at all appropriate. After all, 705 people from the Titanic survived. No one with Japanese assets is going to survive. Everyone is going to lose, the only question will be how much.
Japan’s economy is a particularly atrocious mix of massive debt levels, terrible demographics and a complete lack of natural resources.
The Japanese’ government debt is second to none (from ZeroHedge):
Sovereign Debt to GDP</a> </div></p>
Look closely at that chart. Think about the shrill worries about the US debt level. Then have a look at the Japanese level. They are more than twice as indebted!
And it is not like they are growing. Their demographics are about as bad as any country out there.
Have a look at this chart from the great financial writer Grant Williams:
Japan’s Population</a> </div></p>
Their population growth is collapsing. Their starch refusal to change their immigration policies, combined with a terrible birthrate, is causing the largest slowdown in population growth that the world has ever witnessed in a developed economy.
Finally, it is not like Japan is blessed with a large amount of natural resources. Japan basically has to import everything.
Their economy is a fiasco. How they have managed to coast through for the past couple of decades without imploding is one of the market’s great mysteries. During the past few years the coasting had been slowing to a crawl, and the tsunami disaster was the final headwind that brought the Japanese economy to a full stop. Given the terrible tragedy, the Japanese public was finally ready to make some changes. They elected Prime Minister Abe, who ran on a platform of bold new changes to the economic strategy. His ultra aggressive monetary expansion seemed to be the exact solution that the stuck in the mud Japanese economy needed.
However, how long is it before the market recognizes that the Japanese economy is bankrupt? There is no way that these debts are going to be repaid in real terms. They simply can’t be. It is not a question of whether the Japanese have the will to pay the debt or not. It is a simply a matter of basic math.
I can’t remember the numbers exactly and I am too lazy to look them up, but I think that if Japanese rates rise by 100 basis points, then their entire budget would go to paying for the interest on their debt. Think about that for a second. If rates rose 200 basis points, then even without spending a single Yen on their society their debt would expand. And it’s not like their economy is growing and producing a surplus.
Have a look at this chart that ZeroHedge likes to call the WTF chart:
Sovereign Debt to Revenue</a> </div></p>
The Japanese economy is so screwed.
Prime Minister Abe is making this bold last gamble to kick start growth. But I think in his heart of hearts, he has to know that he is only buying time.
The game is already over. At a government debt to GDP level of almost 250%, with no natural resource wealth and a shrinking population, there is virtually no chance that Japan will be able to grow their way out of their indebtedness.
The end game is already pre-determined. It will be a default – most likely through a massive devaluation.
The only real questions is whether the government will be able to control the default. Will they be able to spread it out over time and ease the transition? After all the default will be far from painless for the Japanese. There will be hundreds of millions of Japanese savers that find their wealth inflated away.
You might be asking yourself – if it is going to hurt so badly, why do it at all? The answer to that question is that the status quo before Prime Minister Abe’s economic reform was an even worse option. That road was a straight downhill slope to a deflationary collapse.
The bold economic plan of Abe is probably the best course of action. He will mouth the words of returning the economy to the growing Japan of the 1980s. But in reality, he has to know that his only hope is to enter into a controlled devaluation that inflates away a good portion of the debts.
This is the third post of my examination of the other Central Banks that might pick up the monetary expansion baton from the Federal Reserve. In my first post I concluded that the ECB was unlikely to do more than talk. China’s outlook was a little more hopeful. Although they were not going to save the day as they did in 2008, I expect them to incrementally step on the accelerator as their economy sags. Japan on the other hand, is the country that I expect to fully take up the baton and charge forward.
The BoJ is already engaged in a Quantitative Easing program that relative to its economy is the largest in modern economic history. Japan is buying almost $70 billion of bonds and other assets each month. This compares to the US that at its height was buying $85 billion a month, but whose economy is more than 2.5 times as big.
Japan is in the midst of the greatest monetary experiment ever conducted. All the other Central Bankers are intently watching whether they can successfully inflate their way out of their economic morass.
Many Western economists believe that Prime Minister Abe is going to get cold feet and ease up on the gas pedal. I think they are making a mistake.
For many years as Japan was in the midst of the deflationary stagnation, Western economists were continually predicting that a change in the economic policies was imminent. The Japanese people astounded most Westerners by patiently allowing their economy to slowly implode without taking any action. After years (decades) of expecting change, the Westerners finally gave up thinking Japan would ever change its stripes. Then when the Tsunami disaster hit, the Japanese people finally reached a point where they were ready for change. They rallied around Prime Minster Abe and put in place their new economic program.
The Japanese people are much more patient than Westerners. They are not prone to running from one side of the boat to the other side. I believe that this economic course that they have set upon with Prime Minister Abe is going to be followed for years and maybe even decades to come.
The Japanese are not going to pull back in the face of the program not working as well as they hoped. In fact, I think just the opposite.
Any lack of progress is only going to be met with a further resolve to increase the program.
When the program was first introduced, it was very effective at lowering the Japanese currency.
JPY (higher rate means lower value of Yen)</a> </div></p>
However the currency has basically been going sideways for more than a year.
The Japanese need a steadily eroding Yen. They want to control the devaluation, but make no mistake – they want the Yen lower.
Therefore given the sideways action of the past year, I think the chances are increasing that Japan increases their QE program in the coming months.
The recent hike in the consumption tax will also likely result in an economic slowdown after the “buying surge before the tax increase” wears off. My guess is that the Japanese government will increase their QE program into that slowdown.
Many financial pundits are focusing on the fact that the Japanese program is not producing the growth that the Prime Minister hoped for. These commentators therefore conclude that the Prime Minister is going to give up.
Ignore these forecasts. There is no way that Japan can go any direction except even more forward.
Of course anything is possible, but I think the Japanese understand that any lack of resolve in their economic reforms would cause a deflationary collapse that would ultimately be even more costly to their economy.
I don’t think that the direction of the Japanese economic policy is the question that needs to be answered. The only answer is whether they are going to be able to control their attempted devaluation.