The third-largest global economy is taking reckless steps to jump-start its languishing economy. Specifically, Japanese Prime Minister Shinzo Abe is taking unprecedented monetary action in an effort to reduce the value of the yen. The near-term effects may be positive for the weak Japanese economy. But the global economic impact could be disastrous for Asia -- and the rest of the world.
Japan has just kicked off a dangerous regional currency war, and there is no end in sight. Even investors here in the U.S. must take note, because the global economic impact could be severe. Recently, the G20 warily approved Japan's new economic plan.
The plan calls for the country to double its monetary base -- and then continue to pump more money into the system until the country reaches an inflation rate of at least 2%. Taken in a vacuum, this move is understandable. Japan has suffered through two decades of economic doldrums. While there are many reasons for the malaise, the chief culprit is Japan's deflation that has persisted since the 1990s.
With deflation, goods cost less tomorrow than they do today -- so no one spends anything. As a result, economic activity grinds to a halt. In that context, Japan's actions make a lot of sense. The yen has been too strong for a long time now, and the only way Japan can get out of its 20-year rut is to force the yen lower.
But this presents a few major problems. The first problem is that Japan has a staggering amount of debt -- well over 200% of GDP. As inflation increases, bond yields will rise to keep pace. And when bond yields go up, Japan will have to pay higher and higher interest on its debt. In other words, within a few short years, Japan's economy will be choked by interest payments alone. And don't even think about the country managing to pay off the principle!
That might sound bad enough. But the second problem is actually much worse. There have been several currency skirmishes since the financial crisis of 2008. The euro has yo-yoed, China gets accused of currency manipulation every year or so, and America has raised eyebrows and whitened knuckles with each new round of quantitative easing.
But this is different. Japan's monetary plan dwarfs all the quantitative easing the U.S. has done since the financial crisis by an order of magnitude. Consider this: By 2015, Japan's monetary base will have ballooned to almost 50% of GDP. By comparison, after all the quantitative easing in the U.S., America's monetary base is still less than 20% of GDP. The eurozone's base -- even with all the bailouts of all the underwater countries -- has grown to only about 15% of GDP.
I've just never seen this much money flood a developed nation before. And this, more than anything else, could be the opening salvo of a new currency war. While the G20 approved Japan's plan, numerous members are privately concerned that this is an aggressive move to devalue the yen above all else -- and may need a response in kind.
In short, there's no upside to this move for an investor. This latest wave of monetary easing highlights the considerable risks in government issued debt. I'll continue to monitor this unfolding story in Japan, and plan to keep you abreast of the latest news. There are many new downside risks, and you'd be wise to avoid the mess of government debt altogether.