Japan will continue its radical quantitative easing but the experiment is getting dangerous. The Bank of Japan is effectively exporting the island nation’s deflation to its trade competitors like Germany, China, and South Korea and inviting a currency war that could shake the world.
By John Mauldin (mauldineconomics.com) from an article* entitled Thoughts from the Frontline – A Five-Year Global Financial Forecast: Tsunami Warning.
“Sayonara” or “Pour Me Some More Sake!”
…The story took a nasty turn on Halloween Day, when the Bank of Japan announced it was greatly expanding and changing the mix of its asset purchases. The results have been downright scary, and a major slide in the JPY/USD exchange rate is almost certain over the next five years. I give it a 90% probability. All this while the population of Japan shrinks before our very eyes.
Some four or five years ago I started saying that Japan is a bug in search of a windshield. [Japan: A Country On the Brink of Fiscal & Economic Disaster!]
Let’s see if I can summarize the problems and opportunities in a few paragraphs.
Essentially, Japan began its lost decades (in 1990) with 30% government debt-to-GDP and is now at 250% (or thereabouts), and the number keeps growing. Well over 90% of government debt is owned by the Japanese themselves, and that number too keeps rising. Nominal GDP is roughly where it was 25 years ago. Growth has been nonexistent. Their massive Keynesian experiment has been a failure, at least as regards its the ability to create growth.
Without getting into the weeds of the actual numbers… the Bank of Japan is currently purchasing the majority of all new Japanese debt that is traded; and some days it is the market in 10-year bonds: no one else does any buying or selling. Japanese pension funds are now rotating out their massive overexposure to Japanese bonds and into Japanese as well as international stocks. We are talking huge cash flows, which is particularly bullish for equities in the developed markets as well as Japan.
If interest rates were to rise by a mere 2%, it would take anywhere from 80 to 100% of all Japanese tax revenues simply to pay the interest on the Godzillaesque Japanese debt. This is not a working business model, as the Japanese are running roughly a 5 to 7% deficit this year, even as interest rates fall due to BOJ purchases.
The Japanese government simply cannot allow interest rates to rise, or it would face an economic catastrophe of the first order. Therefore, my simplistic conclusion is that it won’t but, since the only way you can control interest rates and a rapidly growing bond market is to ensure adequate purchases and demand, and since the only real demand in the country is from the Bank of Japan, the BoJ will continue its radical experiment in quantitative easing. We are talking about a level that is two to three times (in relative terms) the magnitude of recent quantitative easing of the United States – and that is today. I think there is better than a 50% probability that the Japanese will be forced to increase that level of QE, as inflation will prove to be a mirage they chase for the rest of the decade.
They are going to continue monetizing their debt until enough Japanese government debt is on the books of the Bank of Japan that they can afford to allow interest rates to rise. That will be when they get their fiscal deficit under control and are actually running a surplus that could handle a rise in the remaining debt in the public market. Right now their plan is to have a balanced budget by 2020. Any time a politician tells you that the plan is to balance the budget in six years, what he’s really saying is, “I don’t want to take any more heat than I’m already taking today.” In Abe’s defense, he did raise taxes last year, which caused an immediate recession; but he went ahead with the taxes, although he has postponed the next increase until 2017, but QE, Japanese-style, will not end until the Japanese have their budget under control and can allow interest rates to rise. Point: they might stop QE short-term for the purposes of screwing around with the currency markets, but they will be forced to resume.
One of the basic rules of markets is that you can control the quantity of something or the price of something but not both. The Japanese are increasing the quantity of money in the markets, and therefore the value of that money is dropping. The Japanese yen is already down 50% from its highs of just a few years ago. Some would point out that Japan has not disappeared, so why is this a bad thing?
If you are a Japanese consumer, you have seen your disposable income fall as your food and energy costs have risen which is why there has not been an explosion of consumer spending or any appreciable inflation so far, though both were part and parcel of the plan of Abenomics. Japan desperately needs to see nominal GDP growth in the 3% to 4% range, but it is nowhere close. Since the deficit is higher than 3% to 4% and will likely remain so for the next few years, total government debt-to-GDP is rising every year…[which is in the] wrong direction.
While the Japanese government can occasionally back-slap the currency markets with the odd policy correction, long-term they have no choice but to continue to monetize the debt. Not to do so would be to accept a deflationary collapse, something that I think everyone pretty much agrees must be avoided. The time for Japan to make good choices was 15 to 20 years ago, when they should have avoided increasing their debt toward the level where they find it today. Today they have no good choices. They simply have a choice between Disaster A and Disaster B. They have chosen Disaster B, which is to devalue their currency. If I were in their shoes, I would make the same choice. Home team rules and all that.
How low will the yen go? I have said 200 to the dollar, but in reality that is just a guess based on my back-of-the-napkin calculation of how much I think they will need to monetize. I have some very smart friends who think 140 is probably the final number. I have other very smart friends who think 300 is the final number, because they think the government of Japan will lose control over the markets. The reality is that none of us know, as this experiment has never before been tried in the history of the world. Will Japanese consumers (read voters) accept ¥200 to the dollar over the next 10 years? We will see, but I honestly see no choice for them.
If I were Japanese, I would be buying gold and assets not denominated in yen and getting my money into the dollar or other foreign currencies…
[The above article is presented by Lorimer Wilson, editor of www.munKNEE.com and www.FinancialArticleSummariesToday.com and the FREE Market Intelligence Report newsletter (sample here – register here) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. This paragraph must be included in any article re-posting to avoid copyright infringement.]
*Original Source: http://www.mauldineconomics.com/frontlinethoughts/a-five-year-global-financial-forecast-tsunami-warning (Copyright 2015 John Mauldin. All Rights Reserved. See for yourself why over 1 million investors and financial professionals turn to John Mauldin and the Mauldin Economics’ team every week for economic insight. Go to http://www.mauldineconomics.com/subscribe to subscribe. Visit www.mauldineconomics.com/important-disclosures for further details.)
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