Japan's Inflationistas - Getting Cold Feet?

Includes: FXY
by: Acting Man

A Mad-Cap Plan

There has been a remarkable move in the Japanese yen on account of Shinzo Abe unwrapping his mentally unhinged plan to inflate and spend Japan back to prosperity. This cunning plan is of course on a par with "destroying the village to save it." Just because the brigade of deluded Keynesians and other assorted inflationists in the West thinks that one can actually "turn stones into bread," as Ludwig von Mises' characterized such plans, doesn't mean they will actually work.

However, as we have pointed out in previous missives on the topic, it was mostly a matter of perception up until now anyway, at least in terms of monetary policy. Money supply growth in Japan remains to date very low, a fact that has served its aging population very well. While the BoJ has been under immense political pressure for a while already (even before Abe was elected), its policy of announcing inflationary measures to keep the politicians off its back and then only implementing them slowly and in such a manner that the money supply remained fairly stable over time seemed to work just fine.

So what is the effect of 'talking the yen down' by 11%? As Dr. Jim Walker of Asianomics recently pointed out, Japan's export industry represents just 10% of the country's economic activity. So one effect is that 90% of the country's economy have been coerced into subsidizing these 10%. Only a genius like Abe could have come up with that idea. No wait, Krugman might have thought of it as well.

As to the other effects of devaluation, we will quote the aforementioned Ludwig von Mises, who has summarized the problem quite succinctly and trenchantly in Human Action. There really is not much more to say on the topic:

The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare.

In plain language it is to be described in this way: The British citizen must export more British goods in order to buy that quantity of tea which he received before the devaluation for a smaller quantity of exported British goods.

All you have to do is replace 'British' with 'Japanese' in the above paragraph, and you have a description of the true effect of Abe's mad-cap flight forward: nearly everyone in Japan has now become poorer (as is usually the case, inflation, or as it is in this case, a credible threat of coming inflation, is lining the pockets of a minority; everybody else is worse off than before).

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The rate of the yen to the dollar as it is normally quoted (i.e., how many yen are needed to buy one USD). In other words this is actually a dollar-centric way of looking at the exchange rate, as higher levels inidcate a weaker yen - click for better resolution.

Japan's Ponzi Budget and Falsehoods about 'Deflation'

Abe's government has now already implemented one half of his absurd plan, by approving yet another in the endless parade of utterly wasteful Japanese 'stimulus' budgets. Apparently the complete failure of this policy, amply and frequently demonstrated over the span of almost a quarter century by now, is not regarded as an obstacle to doing it all over again, only on an even grander (and thus even more wasteful) scale. It is the very definition of insanity. Is there something in the water in Tokyo? Just asking.

Reuters reports on the breath-taking numbers:

Japan's cabinet approved on Tuesday a 13.1 trillion yen ($146.8 billion) extra budget, which includes 10.3 trillion yen in economic stimulus spending announced last week, as the government tries to boost a flagging economy.

The extra budget, which also contains 2.6 trillion yen to offset a shortfall in the pensions system, takes government spending for the fiscal year ending in March to 100.5 trillion yen, a statement from the finance minister showed.

Compared with previous fiscal years when the government has compiled extra budgets, government spending reached the third-highest on record, a finance minister official told reporters at a briefing.

The government will sell an additional 5.2 trillion yen in government bonds, which would raise bond issuance in fiscal 2012/2013 to 49.5 trillion yen, according to the statement.

For the current fiscal year, the government will rely on bond income to fund 49.2 percent of spending, which is the second-highest ratio on record, the official said. The highest ratio of 52.1 percent was set when the government compiled an extra budget in fiscal 2009/2010 due to the financial crisis.

Japan's cabinet approved an economic stimulus package on Friday in the biggest spending boost since the financial crisis, as Prime Minister Shinzo Abe pursues an ambitious agenda to spur growth and end nagging deflation.

(emphasis added)

Let's clarify a few things about the above. First of all, what's this about the government relying on "bond income" for 50% of its spending? Is it political correctness week? When the government of Japan sells bonds, it is borrowing money, mostly from its own citizens. That's not 'income,' it is simply going further into debt, in Ponzi-like fashion. It means that instead of said citizens holding the money and being able to do with it as they wish, politicians and bureaucrats will decide on how it will be deployed. Only if one believes in the superiority of central economic planning can this possibly make any sense whatsoever. Did we miss something? Is the COMECON still around and rushing from success to success?

The entire tone of the article shows how utterly bizarre economic thinking has become these days. Abe's plan is not an "ambitious agenda." It is a completely deluded scheme that is frankly dangerous to boot, as it is liable to bring the moment of crisis for Japan that much closer. What's so admirable about a politician spending money he doesn't have by borrowing and printing it? Did John Law somehow become the yardstick by which economic policy is judged?

Lastly, we take issue with the terminology employed with regard to deflation. What "nagging" deflation? Last time we looked, Japan's money supply growth remained in positive territory (and we are looking at it frequently). And who thinks a mild decline in consumer prices is a "nagging" problem? Obviously, we can rule out consumers themselves. Their income and savings are buying more goods and services over time. Imagine that! What's not to like?

Ah, but isn't it "bad for business"? This is a falsehood propagated by the proponents of inflation since time immemorial. In reality it is completely immaterial to business whether consumer prices are declining. The only thing that counts is the spread between input and output costs.

Think for moment about electronic gadgets. In the early to mid 1980s, the Cray X-MP "super-computer" series, the top model of which sported a 105 MHZ CPU and the equivalent of 128 MB of RAM, was released. This unit would set you back a cool $16 million (nominal, in 1980 money). A single disk-storing unit, large as a cup-board and capable of storing a respectable 1.2 GB, would cost you another $270,000. Today it is not even possible anymore to buy a computing device that slow with such little storage capacity, but if it were, what might it cost? Ten dollars? Fifteen?

Having cleared that up, we are wondering: where exactly is the severe electronic industry depression that must have been going on since at least 1980? Has anyone ever seen more debilitating "deflation"?

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Meet the 1,2 GB Cray disk drive unit from 1985, price tag $270,000

(Photo via extremetech.com)

Obviously, what is important cannot be 'numbers of monetary units' piling up in accounts - what is important is the creation of real wealth. Mr Abe's allegedly "ambitious agenda" won't create a single yen of real wealth. It has however already destroyed a great deal of it from the point of view of Japan's citizens, without him even trying.

Not So Fast …

However, in recent days the 'success' in driving down the yen appears to begin to worry at least some in Abe's cabinet. Economy minister Akira Amari (everybody has an "economy minister" these days, which may be one of the most useless posts ever invented) expressed worries that the falling yen could lead to a "spike in import prices". Well, duh!

Japanese Economy Minister Akira Amari said the nation faces risks from any excessive decline in the yen, highlighting limits on Prime Minister Shinzo Abe's campaign to drive down the currency.

"If the yen excessively weakens, this would cause a spike in import prices," Amari told reporters in Tokyo today. "It would be a benefit for exports, but would have harmful effects on people's livelihoods."

(emphasis added)

This is the first time in many weeks that anyone over there has said anything that makes sense. Apparently Amari has kept away from that Tokyo water, or from whatever Abe and his other lieutenants are smoking in their bong.

Assorted witch doctors immediately piped up:

Fiscal stimulus and the prospect of more central-bank easing drove a decline of about 10 percent in the yen against the dollar in two months, aiding Japanese exporters as the nation struggles to climb out of recession. Any strengthening of the currency could limit the stock rally that prompted Bank of America Corp. to upgrade its forecast for equities to a 39 percent gain through year-end.

"Further depreciation of the yen is necessary to boost manufacturers' profits and improve price competitiveness," said Junko Nishioka, chief economist at RBS Securities Japan Ltd. and a former BOJ official.

(emphasis added)

No, it ain't "necessary". Japan's exporters have lived with a strengthening currency since 1950. It has made them extremely efficient and has as of yet not had any discernible harmful effects. They may well slacken off now though.

Worst is however that the normally cautious Masaaki Shirakawa seems to have been completely roped in by Abe, at least if we can believe his words:

Bank of Japan Governor Masaaki Shirakawa said today that the nation's economy remains weak ahead of a Jan 21-22 meeting where the central bank will decide whether to add to stimulus for the fourth time in five months.

"Exports and production are decreasing as the global slowdown continues," Shirakawa said at a gathering of BOJ branch managers in Tokyo, adding that the bank will pursue "powerful monetary easing."

(emphasis added)

Of course, as noted above, the BoJ's 'QE' modus operandi so far does not lend itself to fast money supply growth. We suspect that the BoJ buys far more securities from banks than from non-banks, which adds to bank reserves (and grows the proportion of the money supply that consists of covered money substitutes), but creates no additional deposit money in the banking system. The banks themselves meanwhile continue to reduce rather than to expand credit, and they have lately been doing so at a pace that exceeded the rate of monetary inflation engendered by the BoJ. However, this does not mean that a sufficiently determined BoJ cannot alter the situation. In a fiat money system this is ultimately a political decision - there is no economic impediment to inflating the money supply that cannot be easily overcome.

However, we note that the yen (we are now looking at the 'yen-centric' chart) sports a technical divergence at the most recent low, which coupled with the huge speculative short position could be a heads-up that a sizable technical rebound is in store. Should this happen, then we may see a retest of the lows in late March, given the well-established seasonal tendencies in both the yen and the Nikkei.

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The yen: divergences between price and momentum oscillators are beginning to show up

(click for better resolution)

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The yen, public opinion oscillator, by sentimentrader - a composite indicator merging several of the best known sentiment surveys. The bearish consensus on the yen has reached a rare extreme

Will Abe continue to pursue his plan to 'rescue' Japan by impoverishing it? The reality is that one cannot be sure of that. We remain doubtful. For one thing, there have been similar attempts to find salvation in inflation on previous occasions and they have eventually all come to naught. Secondly, the size of Japan's cumulative public debt is beyond good and evil by now. This creates a limit on how much deficit spending and money printing can be pursued before the markets balk. And yet…there is now a clear danger that the 'gray swan' that is Japan's fiscal incontinence finally comes home to roost (so to speak). Perhaps it will turn out to be the 'left-of-field' surprise that unsettles overly complacent risk asset markets this year.

Stay tuned.

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Shinzo Abe, deluded inflationist.

(Photo via nationalturk.com)

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