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The Bear's Lair: The bearish global leading indicator
November 24, 2014
After an unexpected decline in the country's third-quarter Gross Domestic Product (GDP), Japan's Prime Minister Shinzo Abe called an early election last week, while postponing implementation of a sales tax rise into 2017. The global media were generally laudatory, explaining how he could extend his program of indeterminate "reform" while stimulating the economy further by means of a public spending boost. The praise of the media was not unexpected; Abe's policies are simply an extended, bolder form of those practiced almost everywhere else. However, since those policies are mistaken, the result will be highly unpleasant. Japan, for so long the glorious engine of the world economy, now looks likely to be first into disaster.
Even within the halls of Japanese policy, there are signs of dissent. Bank of Japan governor Haruhiko Kuroda expanded the central bank "stimulus" bond purchases to 80 trillion yen ($700 billion) annually on the clear understanding that the second stage of sales tax increases would go through. (By a bill passed by the previous government in 2012 sales tax increased from 5% to 8% in April and was due to increase to 10% in October 2015.) Abe may well get the majority he desires at the election he has called, but to what end? His main post-election idea appears to be to zap the economy with another 5 trillion yen ($43 billion) of spending "stimulus" in the hope that it will do what the first 17 trillion ($150 billion) have failed to do.
This is not so much doubling down on a failed strategy as playing red for the twentieth time when black has come up nineteen times. The fanatic Keynesians in Japanese policy circles have failed to examine critically their actions over the past two decades, or to correct their mistakes. Japan's quarter-century malaise (as of Dec. 31, the 25th anniversary of the 1989 peak of the Tokyo Stock Exchange's Nikkei index) has not been due to any great failing in the Japanese economy, nor to any supposed demographic disaster from Japan's aging. It simply has been due to from the complete failure of Keynesian spending stimulus combined with Bernankean monetary stimulus, repeated ad infinitum.
As of 1990, Japan was macro-economically a well-run country. Government spending was only 30% of GDP, while the Bank of Japan's discount rate at the start of 1990 was 4.25% against a 1990 inflation rate of 3% (in retrospect, it should have been higher, and indeed the Bank of Japan realized this, raising the discount rate to 6% by August 1990).
A massive backlash from the 1980s stock market bubble was inevitable, and real estate prices needed to drop 50% or more in urban areas, having been driven up much too far in the late 1980s. On Austrian economic principles, the malinvestment needed to be driven out. There was no question, therefore, that a substantial recession was inevitable. However there was no reason to expect that recession to last more than a few years, after which the resilience and dynamism of the Japanese economy would take it back to new heights.
As we know, history didn't turn out like that. In 1990-91, the Japanese authorities pursued orthodox economic policies to stem the bubble, with considerable success. The stock market index was down to half its peak level by late 1990. Then from 1992 the Keynesians took over and what had been a conventional if sharp economic downturn prolonged itself ad infinitum, with stagnation about to enter its 26th year. Public spending, which had been held below 30% of GDP until 1991, increased to 35% in 1996 and 38% in 2000. With only a sales tax increase from 3% to 5% by the Hashimoto government in 1997 doing anything to balance the budget, deficits soared. So did Japan's public debt, which had been at 60% of GDP in 1990 but quickly soared higher than 100% and kept climbing.
Following the advent of Prime Minister Junichiro Koizumi in 2001, it appeared that Japanese policymakers had come to their senses. Japanese public spending was dragged down from 37% of GDP in 2000 to a low of 33.5% in 2007, while deficits began ever-so-slowly to decline. If Koizumi had been granted the 11 years in power of Margaret Thatcher, let alone the 16 years in power of Helmut Kohl, Japan's problems would have been solved—although the global financial crisis of 2008-09 would doubtless have caused a hiccup. Maybe even with the eight years of Ronald Reagan, Koizumi could have done it, although that would have ejected him from office in mid-2009, a dangerous recessionary time to let the Keynesian wolves back in.
But Koizumi lasted only five years, barely long enough to visit Elvis' home with President George W. Bush, and his successor Abe was ejected from office in only a year. By 2007 the big-spending Keynesians were back in control and the result was a further inexorable rise in Japanese government spending to a peak of over 40% in 2011, at which level it has remained. Truly, Japan's habit of rapidly rotating its politicians has a lot to answer for. Koizumi had the solution to Japan's decades-long problem and wasn't allowed enough time to implement it properly.
Meanwhile Japanese government debt has climbed to 240% of GDP. (The largest debt that has ever been successfully paid down was about 250% of GDP, achieved by Britain twice. The first followed 1815 without inflation, and the other happened after 1945, with continual, very damaging inflation and destruction of private savings.) Japan's budget deficit in the year to March 2015 will be about 8% of GDP, the highest in the world outside countries like Egypt and Venezuela. That's a figure from a full five years after the last real Japanese recession, as distinct from the ongoing 25-year recession that blights the Japanese economy.
The solution to Japan's problems is not to double down on them. The reality is that the inexorable expansion of the state sector and the continual drain on Japan's investment funds to fund the budget deficits have weakened Japan's economy—possibly terminally—giving it the profile of a bloated Brazil rather than the technological powerhouse of growth which it was. Printing money like madmen makes the problem worse because it allocates resources from the central bank using non-market criteria. Raising the sales tax at least lessens the deficit's drain on the economy (probably without lessening the eventual probability of debt default, which that seems almost inevitable.) However, by draining yet more purchasing power from the private sector, it has caused another short-term recession that has sent Japan's policymakers into full panic mode.
The solution is simple: the opposite of what Japan has done for the last quarter-century except for an all-too-brief period under Koizumi. The government must be cut back, ideally to 30% of GDP, in order for the budget to be balanced at the earliest possible date. Abe has promised to balance the budget "before debt service" by 2020. But that is taking the spendthrift Brazilian approach to public accounting, looking only at the "primary surplus" while running large deficits after interest has been paid. Japan's debt must either be serviced or defaulted on, and a proper accounting includes debt interest among the government's costs.
It is probably necessary to implement the second sales tax increase, from 8% to 10%, in order to balance Japan's budget. Japanese sales taxes are lower than in most of the West, and a tax bearing on consumption is less damaging than one bearing on income. Like the last sales tax increase, the new one will produce a dip in GDP, but only a temporary one, which must be borne as the price of excessive wasteful government profligacy over so long a period. Government spending reductions are preferable to tax increases, because they reduce the percentage of resources allocated by the corrupt public sector. But in Japan's case, with such a large deficit, sustained over such a lengthy period, both are probably necessary.
So when you hear a re-elected Abe announce that his new "stimulus" spending program will revive the Japanese economy, don't believe a word of it. It will be the reverse of what's needed and will bring Japan's economic catastrophe closer.
For the rest of us, Japan's example is important not simply for those of us who admire the Japanese, believing that in certain policy respects—immigration and elder care among them—their society is an example to the world. It also shows the likely trajectory of the world's major economies, if they continue on their present path of excessive public sector deficits financed by printing money. Japan's public debt catastrophe in 2016 or 2017, which will cause a major economic downturn worldwide by itself, will be replicated in a global public debt catastrophe around 2028 or 2030 on the present trajectory.
The one hope, and it doesn't do much for Japan, is that Japan's fate will cause a massive rejection of Keynesian "stimulus" economics in the West, which will lead to an era of tight money, balanced budgets and high consumer savings, which will repair the world's balance sheets. Such a rejection is urgently needed. The continuation of misguided Keynesian policies without short-term catastrophe occurring is giving those policies a spurious intellectual respectability. It is also piling up public and private sector malinvestment, the destruction of which will cause a massively painful recession.
http://www.prudentbear.com/2014/11/the-bears-lair-bearish-global-leading.html#.VHVN5yh8vzI
November 24, 2014
After an unexpected decline in the country's third-quarter Gross Domestic Product (GDP), Japan's Prime Minister Shinzo Abe called an early election last week, while postponing implementation of a sales tax rise into 2017. The global media were generally laudatory, explaining how he could extend his program of indeterminate "reform" while stimulating the economy further by means of a public spending boost. The praise of the media was not unexpected; Abe's policies are simply an extended, bolder form of those practiced almost everywhere else. However, since those policies are mistaken, the result will be highly unpleasant. Japan, for so long the glorious engine of the world economy, now looks likely to be first into disaster.
Even within the halls of Japanese policy, there are signs of dissent. Bank of Japan governor Haruhiko Kuroda expanded the central bank "stimulus" bond purchases to 80 trillion yen ($700 billion) annually on the clear understanding that the second stage of sales tax increases would go through. (By a bill passed by the previous government in 2012 sales tax increased from 5% to 8% in April and was due to increase to 10% in October 2015.) Abe may well get the majority he desires at the election he has called, but to what end? His main post-election idea appears to be to zap the economy with another 5 trillion yen ($43 billion) of spending "stimulus" in the hope that it will do what the first 17 trillion ($150 billion) have failed to do.
This is not so much doubling down on a failed strategy as playing red for the twentieth time when black has come up nineteen times. The fanatic Keynesians in Japanese policy circles have failed to examine critically their actions over the past two decades, or to correct their mistakes. Japan's quarter-century malaise (as of Dec. 31, the 25th anniversary of the 1989 peak of the Tokyo Stock Exchange's Nikkei index) has not been due to any great failing in the Japanese economy, nor to any supposed demographic disaster from Japan's aging. It simply has been due to from the complete failure of Keynesian spending stimulus combined with Bernankean monetary stimulus, repeated ad infinitum.
As of 1990, Japan was macro-economically a well-run country. Government spending was only 30% of GDP, while the Bank of Japan's discount rate at the start of 1990 was 4.25% against a 1990 inflation rate of 3% (in retrospect, it should have been higher, and indeed the Bank of Japan realized this, raising the discount rate to 6% by August 1990).
A massive backlash from the 1980s stock market bubble was inevitable, and real estate prices needed to drop 50% or more in urban areas, having been driven up much too far in the late 1980s. On Austrian economic principles, the malinvestment needed to be driven out. There was no question, therefore, that a substantial recession was inevitable. However there was no reason to expect that recession to last more than a few years, after which the resilience and dynamism of the Japanese economy would take it back to new heights.
As we know, history didn't turn out like that. In 1990-91, the Japanese authorities pursued orthodox economic policies to stem the bubble, with considerable success. The stock market index was down to half its peak level by late 1990. Then from 1992 the Keynesians took over and what had been a conventional if sharp economic downturn prolonged itself ad infinitum, with stagnation about to enter its 26th year. Public spending, which had been held below 30% of GDP until 1991, increased to 35% in 1996 and 38% in 2000. With only a sales tax increase from 3% to 5% by the Hashimoto government in 1997 doing anything to balance the budget, deficits soared. So did Japan's public debt, which had been at 60% of GDP in 1990 but quickly soared higher than 100% and kept climbing.
Following the advent of Prime Minister Junichiro Koizumi in 2001, it appeared that Japanese policymakers had come to their senses. Japanese public spending was dragged down from 37% of GDP in 2000 to a low of 33.5% in 2007, while deficits began ever-so-slowly to decline. If Koizumi had been granted the 11 years in power of Margaret Thatcher, let alone the 16 years in power of Helmut Kohl, Japan's problems would have been solved—although the global financial crisis of 2008-09 would doubtless have caused a hiccup. Maybe even with the eight years of Ronald Reagan, Koizumi could have done it, although that would have ejected him from office in mid-2009, a dangerous recessionary time to let the Keynesian wolves back in.
But Koizumi lasted only five years, barely long enough to visit Elvis' home with President George W. Bush, and his successor Abe was ejected from office in only a year. By 2007 the big-spending Keynesians were back in control and the result was a further inexorable rise in Japanese government spending to a peak of over 40% in 2011, at which level it has remained. Truly, Japan's habit of rapidly rotating its politicians has a lot to answer for. Koizumi had the solution to Japan's decades-long problem and wasn't allowed enough time to implement it properly.
Meanwhile Japanese government debt has climbed to 240% of GDP. (The largest debt that has ever been successfully paid down was about 250% of GDP, achieved by Britain twice. The first followed 1815 without inflation, and the other happened after 1945, with continual, very damaging inflation and destruction of private savings.) Japan's budget deficit in the year to March 2015 will be about 8% of GDP, the highest in the world outside countries like Egypt and Venezuela. That's a figure from a full five years after the last real Japanese recession, as distinct from the ongoing 25-year recession that blights the Japanese economy.
The solution to Japan's problems is not to double down on them. The reality is that the inexorable expansion of the state sector and the continual drain on Japan's investment funds to fund the budget deficits have weakened Japan's economy—possibly terminally—giving it the profile of a bloated Brazil rather than the technological powerhouse of growth which it was. Printing money like madmen makes the problem worse because it allocates resources from the central bank using non-market criteria. Raising the sales tax at least lessens the deficit's drain on the economy (probably without lessening the eventual probability of debt default, which that seems almost inevitable.) However, by draining yet more purchasing power from the private sector, it has caused another short-term recession that has sent Japan's policymakers into full panic mode.
The solution is simple: the opposite of what Japan has done for the last quarter-century except for an all-too-brief period under Koizumi. The government must be cut back, ideally to 30% of GDP, in order for the budget to be balanced at the earliest possible date. Abe has promised to balance the budget "before debt service" by 2020. But that is taking the spendthrift Brazilian approach to public accounting, looking only at the "primary surplus" while running large deficits after interest has been paid. Japan's debt must either be serviced or defaulted on, and a proper accounting includes debt interest among the government's costs.
It is probably necessary to implement the second sales tax increase, from 8% to 10%, in order to balance Japan's budget. Japanese sales taxes are lower than in most of the West, and a tax bearing on consumption is less damaging than one bearing on income. Like the last sales tax increase, the new one will produce a dip in GDP, but only a temporary one, which must be borne as the price of excessive wasteful government profligacy over so long a period. Government spending reductions are preferable to tax increases, because they reduce the percentage of resources allocated by the corrupt public sector. But in Japan's case, with such a large deficit, sustained over such a lengthy period, both are probably necessary.
So when you hear a re-elected Abe announce that his new "stimulus" spending program will revive the Japanese economy, don't believe a word of it. It will be the reverse of what's needed and will bring Japan's economic catastrophe closer.
For the rest of us, Japan's example is important not simply for those of us who admire the Japanese, believing that in certain policy respects—immigration and elder care among them—their society is an example to the world. It also shows the likely trajectory of the world's major economies, if they continue on their present path of excessive public sector deficits financed by printing money. Japan's public debt catastrophe in 2016 or 2017, which will cause a major economic downturn worldwide by itself, will be replicated in a global public debt catastrophe around 2028 or 2030 on the present trajectory.
The one hope, and it doesn't do much for Japan, is that Japan's fate will cause a massive rejection of Keynesian "stimulus" economics in the West, which will lead to an era of tight money, balanced budgets and high consumer savings, which will repair the world's balance sheets. Such a rejection is urgently needed. The continuation of misguided Keynesian policies without short-term catastrophe occurring is giving those policies a spurious intellectual respectability. It is also piling up public and private sector malinvestment, the destruction of which will cause a massively painful recession.
http://www.prudentbear.com/2014/11/the-bears-lair-bearish-global-leading.html#.VHVN5yh8vzI
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