The economy is rebounding. The housing crisis is easing. And there’s no plausible reason to worry about inflation, since the Federal Reserve will soon begin retreating from its quantitative-easing program.
This view is widespread, attractive, and wrong.
Here’s why: In an article published in The National Interest on April 16, I suggested that “the Fed cannot cease its easing. Indeed, it will have to increase the size of its monetization programs, because Japan has just leapfrogged the Fed. The Bank of Japan (BOJ), under its new governor, Haruhiko Kuroda, just announced that it will purchase 7.5 trillion yen (that’s $75 billion) per month in Japanese government bonds. Yes, $75 billion is less than the Fed’s $85 billion, but Japan’s GDP is only a third the size of the U.S. GDP. So the BOJ’s monetization program is much more aggressive than even Ben Bernanke’s. In fact, the BOJ’s actions will double that nation’s monetary base over the next two years.” What I wrote then is truer than ever.
In the intervening four months, endaka, or “strong yen”, has been broken. At the end of 2012, one U.S. dollar could purchase fewer than 85 yen. By mid-May of 2013, about six weeks after the BOJ’s debt-monetization program was announced, one U.S. dollar could purchase more than 103 yen. The dollar has since weakened somewhat against the yen, but it still is 13 percent stronger against the Japanese currency.
What was the purpose of the BOJ’s aggressive money-printing program? Quite simply, to reverse the decades of deflation and stagnant real economic growth since the Japanese “economic miracle” ended in 1990. Despite spending more than 60 trillion yen (approximately $600 billion, but equal to approximately $1.8 trillion in U.S.-GDP-equivalent spending) on Keynesian stimulus programs (scores of roads and bridges and other shovel-ready projects to nowhere) in fourteen supplementary budgets since 1998, the Japanese GDP has risen at less than one half of one percent, on average, over the last three fiscal quarters.
Although the island nation’s GDP has barely budged, the same cannot be said for Japanese government debt. Japan’s public debt has grown from about 60 percent of GDP in 1990 to over 230 percent today. At the rate of deficit spending planned by Japanese prime minister Shinzo Abe for the rest of 2013, about 10 percent of GDP, that ratio could top 240 percent in 2014.
In actual currency, Japan’s debt has crossed the quadrillion yen threshold. That is a 1 followed by 15 zeros. Of course, with a yen being worth a (U.S.) penny, Japan’s debt is equivalent to $10 trillion. But with a GDP equal to one-third the size of U.S. GDP, Japan’s debt is like the U.S. having a $30 trillion national debt, about twice its actual size of just under $17 trillion, which is the largest absolute national debt of any nation in all of modern history.
With fiscal policy having failed, Prime Minister Abe and BOJ governor Kuroda opted to roll the same pair of quantitative-easing dice Bernanke will use to gamble more than a trillion of the Fed’s fiat dollars on kick-starting growth in the United States in 2013. The “out of thin air” money that Kuroda is printing will be used to purchase 70 percent of newly issued Japanese government bonds, as well as to buy ETFs (exchange traded funds) traded on the Tokyo exchange. Bernanke has been purchasing “only” 60 percent of U.S. Treasury emanations, and even he has not purchased ETFs.
The BOJ bond purchases are aimed at the “long end of the curve,” bonds due many years from now. That has reduced yen interest rates to such an extent that the so-called “carry trade” has been reenergized, allowing investors to borrow in yen at very low interest rates and invest elsewhere at higher rates, profiting from the interest rate differential. In order to invest the borrowed yen in other economies, the yen borrowers have to sell the borrowed yen. This yen selling drives down the value of the yen (more supply compared to the exchanged currency), thereby decreasing the dollar or yuan or euro price of Japanese exports. Increased exports would revive the Japanese economy, increase hiring, increase tax collections...and the sun again would rise over Japan.
At least that is the theory. Has it worked? Not by a long shot.
Since Abe and Kuroda embarked on their reckless experiment on the world’s third largest economy, exactly the opposite of their initiative’s intended results has been observed. For the first six months of 2013, Japan treated itself to its largest trade deficit in history, courtesy of the lower yen. As the yen has fallen, the prices of goods imported into Japan have risen quickly, much more quickly than exports have increased. So much so that over the first half of 2013, Japan’s trade deficit reached 4.8 trillion yen ($48 billion), an increase of 66 percent from one year earlier.
Will Japanese exports really increase over the coming months and years? In a theoretical, static world, maybe. But in the real, dynamic world, not a chance, at least not in a sustained way. Why? Two main reasons: First, endaka (strong yen) during much of the time period before 2013 caused traditional Japanese exporters to move production facilities overseas to much cheaper areas. As a result, many “Japanese” goods now are actually Chinese or Korean or Filipino or Vietnamese. Therefore, the lower yen does not increase shipments of these products from Japan. In fact, many of these goods now are imported by Japanese retailers at increased prices, reflecting the yen’s decline.
Second, other nations will retaliate against a lower yen. They will monetize their own debts, increasing the supply of their own fiat currencies, driving down those currencies’ values. There is no impediment to this. Indeed, Bernanke has been doing it for five years. The European Central bank certainly will join the party.
This race to the bottom will bankrupt savers, lead to very high rates of inflation and more asset bubbles. Gold remains the only viable exit strategy. When those bubbles burst, and burst they will, 2008 will seem like the good old days.
Jay Zawatsky is the CEO of havePower, LLC (a natural gas infrastructure developer) and a professor of business, economics, and finance at Montgomery College in Rockville, Maryland.
Image: Flickr/IvanWalsh.com. CC BY 2.0.