Tuesday, January 15, 2013

Mr. Abe’s Trigger

Prime Minister Shinzō Abe

The newly elected Japanese Prime Minister, Shinzō Abe, has caused quite a stir. The leader of the Liberal Democratic Party, which scored a landslide victory in 2012’s election, he’s promised to restart the Japanese economy, whatever it takes.

How will he do this? He “will implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment, and with these three policy pillars, achieve results”—according to his statement following the LDP election victory.

By “bold monetary policy”, what he means—and what he has said—is to end the independence of the Bank of Japan, and have the government dictate monetary policy directly. (You could argue whether any central bank in any of the developed economies is truly “independent”—or indeed, has ever been so. But for the sake of this discussion, let’s assume that they have been.)

The perception is, the Bank of Japan will not only print yens and buy government bonds à la Quantitative Easing of old—it is also generally thought that Mr. Abe and the incoming Japanese government fully intend to target the yen against foreign currencies, like Switzerland has been doing with the euro.

This perception is what has been driving the Nikkei 225 index higher, and driven the yen lower. Prime Minister Abe’s policies have yet to be fully implemented—so far, it’s all been just talk. But the markets are taking Mr. Abe at his word, convinced that he is going to set a policy very similar to what the United States and the Federal Reserve have been doing: Targetting the equities markets, and printing in order to bring the yen down, and thus make Japanese products competitive in foreign markets.

But why was this decision triggered? For going on twenty-three years, Japan’s GDP growth has been sluggish at best, it’s government amassing huge debts, all the while the yen slowly strengthening and the Nikkei index meandering—yet all of a sudden, now the Japanese government is ready to do whatever it takes to turn the Japanese economy around, which begs the question: Why now?

Simple: Japan’s balance of trade has turned decisively negative for the first time since the Oil Shock of 1980—and this has put the fear of God into the Japanese leadership. Look at the following chart:

Click to enlarge.

Since the Iranian Oil Shock of ‘79, Japan has consistently held a positive balance of trade—until 2011. And 2012 was a nasty shock, as the balance of trade went full-on negative. Japan had a trade deficit for the first time in 33 years.

This was Mr. Abe’s trigger.

In a very real sense, Japan could afford to have an economy in the doldrums because it was a net creditor nation. The United States and Europe might follow Keynesian claptrap that “deficits don’t matter”, be they fiscal deficits or trade deficits. But the Japanese believe that trade deficits matter.

Japan don’t seem to mind about fiscal deficits: If the government was overindebted, the Japanese people were down with it, as shown by the polls—because the Japanese people were the ones financing the Japanese government’s deficit. Consider this chart:

As can be seen, over 85% of the Japanese government’s debt is held by the Japanese. So although Japan’s fiscal debt is monumental—over 230% of GDP, dwarfing the U.S.’s figure of 110% of GDP—it has never been that much of a political issue in Japan, because it is internal. It is money the Japanese government owes the Japanese people.

But the turn to deficit in the balance of trade has the Japanese public and political establishment shitting lead bricks, to use a highly specialized, technical socio-economic term for the situation they are in.

This is why Mr. Abe’s LDP party won so decisively: The deficit in the balance of trade proved to be politically unacceptable. Mr. Abe won by promising to turn that deficit into a surplus.

Now, how can Mr. Abe do that? Well, if you want to export more than you import, a country has to produce stuff that other countries want—or make foreign imports expensive. What’s the quickest way to make a country’s goods cheap so that others buy them, while making imports that much more expensive? Easy-peasy, Japan-easy: Devalue the currency.

And that’s what Mr. Abe is proposing. Not in so many words, but he is saying that the Bank of Japan’s autonomy ought to end, and that monetary policy should be directly under the thumb of the government.

Since a fiat currency like the yen cannot be devalued by diktat, the only way for it to fall is relative to other currencies—like the dollar, the euro, or the pound sterling.

How do you get a fiat currency that is the region’s reserve currency to fall against other foreign reserve currencies? Simply by buying up foreign sovereign debt with your local currency, flooding foreign markets with your currency, and thus driving down its value against the dollar, the euro and the pound.

This is basically what the Swiss have been doing, by targetting the Swiss franc at CHF1.20 to the euro. And this is what Prime Minister Abe and his government plan on doing—of course on a much larger scale, considering how much bigger Japan is than Switzerland.

Prime Minister Abe also unveiled a massive ¥10.3 trillion (US$116 billion) stimulus package. Adjusting for the size of the GDP, this Japanese stimulus would have been equal to a $296 billion package in the United States. An impressive-enough number.

But the Abe stimulus is a sideshow—the real issue is the devaluation of the yen.

Devaluation is the only way for Japan to make its exports cheaper and its imports more expensive—and this flies directly in the face of what is going on with Japan’s historic deflationary trend, which as I explained in the previous section of this discussion, is a product of the demographic realities of Japan that are inevitable.

But this is where Mr. Abe wants to go. And the trigger for this radical—extremely radical—approach was not the sluggish GDP, nor was it the massive fiscal deficit, no: It was all triggered by the rising Japanese trade deficit.

Here is where economic realists have to tread very, very carefully, lest they be blown out of the water by something I call Cassandra’s Blindness. In the next section, I will discuss some investment ideas I think might be worthwhile, considering the new reality going on in Japan.
This post was adapted from an in-depth analysis of Japan that recently appeared in my Strategic Planning Group. If you are interested, please check out the preview page.


  1. good stuff

    the beggar neighbor stuff is going to go parabolic soon

  2. Good to see you back. Always look forward to your posts. Thanks

  3. Really, GL? Japan?

    C'mon, man!

    You and I and anyone who has a pulse knows the real story is not Japan, but Germany.

    Germany has taken a hint from Justin Timberlake. But instead of bringing sexy back, it wants to bring its gold back.

    In the immortal words of Bugs Bunny -

    "Of course you realize, this means war."

    Currency war.

    Currency wars have a nasty habit of morphing into real wars.

    Anyone care for popcorn?

    K Smith

  4. Last week's issue of Science was all about inflammation. There was a lead article about how inflammation is an integral part of atherosclerosis - heart disease. That got me thinking. What runs in the blood has an impact on the integrity of the walls of the vessels. Put hamburgers, french fries, and ice cream in your blood stream and soon enough very nasty deposits start to build up behind the lining of the vessels - we call that plaque, or hardening of the arteries. You don't know much about its presence until the vessel is about 90% occluded. Then the plaque breaks, it bleeds, a clot forms, and everything down stream is starved for oxygen. If the vessel happens to, say, feed the muscle of the heart, you're toast. I think that what the bankers have done is put the equivalent of junk food into our collective bloodstream - and the plaques are building up everywhere. We had a mini-stroke or mild heart attack in 2008, but recovered and are being force fed the same garbage. When the plaque blows next time, the heart will stop and everyone downstream will starve. Isn't it interesting... the fractal nature of things: heart disease and financial poisoning have so much in common, wouldn't you say?

  5. Shinzo Abe is a returnee to the PM position. He was the last LDP PM before the Democratic Party of Japan, the DPJ, was given a (few years) shot at running the government. Abe is th rabid nationalist grandson of Nobosuke Kishi, who served as PM in the fifties and served in the wartime Japanese cabinet. He is I think a political idiot with a myopic view of the world. During the six powers talks in Beijing, Abe focused on the demand that NK account for the kidnapped Japanese abductees instead of the far more important topic of negotiating a non-nuclear Korean peninsula. You would think that this latter topic would be a front burner topic for Japan as well as the other powers but Abe completely ignored it and almost succeeded in distracting from the real purpose of the conference. The LDP was Japan's overwhelmingly leading political party for 50 years after the war, but confusion and defections have damaged its prestige and profile on almost every important matter for the past 20 years. Like the US Republican party, the LDP is seriously adrift and unable to think clearly and constructively on most issues today. For example, after the Fukushima nuclear disaster, the DPJ decided to change course on nuclear power and adopt a policy of phasing out nuclear power in favor of less dangerous renewable sources like solar and wind. Abe has announced that he will reemphsize nuclear power despite its overwhelming unpopularity after the Fukushima disaster.

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  8. Today's Wall Street Journal (April 3, 2013)had two major articles on Japanese economics focused on the takeover of the Central Bank by the new appointee, Haruhiko Kuroda, formerly head of the Asian Development Bank. The new PM Shinzo Abe dismissed the BOJ head Shirakawa because he wouldn't agree to set a 2% inflation target to stimulate the economy out of its long term stagnation. Kuroda is more amenable to going along with the 2% target despite the supposed independence of the BOJ. The first article, "Japan Central Bank Plan Meets Skepticism", claims that a chorus of criticism from inside and outside the government aren't convinced that the inflation target is attainable. Unless the public believes such a target is attainable, it could be difficult for the government to launch its plan successfully. An opposition spokesman said the economy would have to grow at 4% to attain the 2% target for inflation and this would take two years. At a time when the world economy is bearly growing, this could be a disaster for Japan. Kuroda himself says the public must believe the inflation target is attainable for the plan to work. Skeptical economists say the plan cannot work because wages have fallen 9% since 1997 and this won't change for the forseeable future. The second article, "Rare Jitters for JGB", says the uncertainty about Abe's economic program is causing wild fluctations in the price of JGB. As you know a number of knowledgable western analysts like Kyle Bass and Marc Faber are predicting that Japan will suffer from steep economic problems because of its government debts which far exceed those of any other major economy. Could we be seeing Abenomics turning into Zimb-abenomics in the future?

  9. The BOJ announced Thursday that it will engage in "massive" government bond-buying program that will double the monetary base from Y135 trillion to Y270 trillion in two years. The average maturity of the purchase will lift the average from three to seven years. The BOJ will expand their balance sheet by 1% of GDP every month for the next two years. This is double the rate of the Federal Reserve's quantitative easing program. The announcement came after the first meeting of the board and the new governor Haruhiko Kuroda who has abandoned the independence of the BOJ under the former governor Masaaki Shirakawa. The target which was set by the new Prime Minister Shinzo Abe is to raise inflation to 2% within two years. The Financial Times columnist Gavyn Davies says this is a breathtaking risky step by Japan. It will have imported the Fed's entire post-Lehman balance sheet strategy and he will implement it in two years instead of the five years that Ben Bernanke took. Another article in the FT, says foreign interests are planning a massive short program for JGB. This strategy will upset the foreign exchange markets as it will drive down the value of the yen. This will contribute to mounting instability of the international monetary system and the deepening crisis of global capitalism. As I said earlier, this new PM Shinzo Abe is a political idiot in foreign policy and now it appears in economic policy as well.

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