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A Fount of Economic Fallacies

After Japan has been berated by Western economists for more than 20 years, the mad-cap flight forward by the Abe administration is suddenly held to be able to 'teach us something' about what should be done with regard to economic stagnation. It is amazing what a little rally in the stock market and a few highly suspect GDP releases can accomplish.

As the LA Times writes in a recently published article entitled "Japan's economy is bouncing back, offering a possible model for U.S.", Abenomics (i.e., the same hoary inflationism that has been tried over and over again since John Law) is where it's at. The article is interesting mainly because it is a fount of economic fallacies on a par with Shinzo Abe's policies. An excerpt:

After two decades of economic stagnation, once-mighty Japan is beginning to revive - under policies that some experts say could offer lessons to the still-struggling economies of the United States and Europe.

While the eurozone tries to break out of recession and the U.S. economic recovery remains anemic, Japan has begun to grow at an encouraging rate.

The shock-therapy policies of Prime Minister Shinzo Abe have helped Japan's economy expand for three straight quarters at a pace faster than that of the United States.

Its stock market has surged more than 50% in less than a year. Leading automakers and even long-struggling electronics firms such as Sony Corp., beaten down by Apple Inc. and Samsung Electronics Co., are reporting a jump in profits.

The combination of government and financial measures popularly know as Abenomics may finally be snapping Japan out of the doldrums, and that is drawing increasing attention from economists in the West.

Japan's struggles with deflation and a rapidly aging society are in many ways unique, but some of the problems that have long trapped Japan, including sagging incomes and structural weaknesses, are similar to those dogging the U.S. and Europe.

"It may have quite a lot to teach us," Joseph Stiglitz, the Nobel laureate economist, wrote recently. "If Abenomics is even half as successful as its advocates hope, it will have still more to teach us."

Japan's central bank has begun to pump more cash into its economy, lifting the nation's exports by reducing the price of Japanese products in the global marketplace.

In addition to adopting strong monetary policy, Abe has boosted government spending to put more money into the pockets of Japan's citizens. The U.S. and Europe, by contrast, have largely emphasized cutbacks, an approach economic studies suggest have slowed job creation and overall growth.

(emphasis added)

Heaven help us if Western experts think we should imitate this nonsense, especially if one of those experts is arch-Keynesian Joseph Stieglitz. Frankly, it is actually hard to see in what way Japan's policies differ from those practiced in the West; the main difference is that it is closer to its ultimate debt catastrophe.

Anyway, Japan cannot 'teach us' anything, but the above quoted LA Times article can.

The Errors Enumerated

The stock market has surged, it is true. That can easily happen when the central bank embarks, or threatens to embark, on a hugely inflationary policy and the currency's value plunges. Of course said market remains 65% below its bubble peak attained almost 24 years ago, so it may be a bit early to celebrate its revival. In the bigger scheme of things the recent rally is but a blip on the chart, although it certainly looks promising from a technical perspective (that may actually be a very bad sign for the yen):

(click to enlarge)

The Nikkei index over the past quarter century

It is easy to throw a party when the central bank inflates like crazy, but that doesn't mean the policy is economically sensible. We recently talked briefly about Germany's hyperinflation: in mid 1922, unemployment had fallen well below 1% (!). Surely the inflation policy was 'working'? Alas, by late 1923 the unemployment rate was at 29%. More than two decades of major economic and political upheaval followed - in the end, Germany was a pile of rubble.

There was never a 'struggle with deflation' in Japan. The Japanese money supply has grown slowly over the past two decades, but it has at no point deflated. Prices fell ever so mildly, a great boon for the citizenry. Why everybody seems to think that Japan's citizens are better off when everything becomes more expensive for them remains a great mystery. Given Japan's demographic backdrop, a policy of inflation does not even make superficial sense. The old Keynesian trick of trying to betray wage earners by lowering their real incomes via inflation in order to temporarily raise employment has never been more misguided than in Japan with its sub 4% unemployment rate and shrinking population.

The BoJ has not merely made 'Japan's products cheaper' - it has contributed to crashing the exchange value of the yen. So what are we supposed to do now, if it is true that this policy has something to 'teach us'? Not everyone can devalue their currency against all other currencies at the same time after all. Besides, the alleged gains that come from currency devaluation are 100% ephemeral. There is no lasting benefit to be had. All it means is that Japan's citizens are now forced produce far more than previously if they want to obtain the same amount of goods and services from abroad as before. The accounting profits of the fairly small coterie of exporters are temporarily rising, but eventually domestic prices will adjust to the situation and then the seeming advantage will be gone entirely. Note by the way that Japan has a trade deficit these days.

In fact, Japan's policy makers should probably be concerned about the possibility that a currency crisis may engulf Japan sooner or later unless they step back from their schemes. This is one reason why the bullish looking Nikkei chart is actually slightly worrisome - in a currency crisis, the stock market would probably soar in nominal terms (although it would likely become quite worthless in real terms if history is any guide).

(click to enlarge)

A daily chart of the September yen futures contract. The yen has just broken down again from a triangle formation

Finally, the assertion that "Abe has boosted government spending to put more money into the pockets of Japan's citizens." is utterly ludicrous. Every single yen Japan's government is 'putting into the pockets of its citizens' it must first take out of their pockets, whether by taxation, borrowing or inflation.

The government possesses no secret stash of resources it can distribute when needed. Every yen by which government spending increases is a yen Japan's citizens can no longer spend. The difference is only that the spending decisions are made by bureaucrats now instead of by private citizens. Since bureaucrats have no possibility to conceive of the categories profit and loss and cannot ascertain the opportunity costs associated with their spending, most of it will turn out to be wasteful (Japan already has countless 'bridges to nowhere' that are testament to this fact).

It certainly is a great way to hasten the consumption of capital, but that is all there is to it. The fact that government spending counts as a positive factor in the calculation of GDP does not make Japan one iota richer. On the contrary, it will help to mask its coming impoverishment.

Furthermore, with the government's debt about to surge to 240% of GDP this year and debt service costs alone devouring 25% of tax revenues, a sovereign debt crisis is highly likely to erupt at some point. At this stage, JGB yields remain at a very low 78 basis points, as market participants do not yet believe the inflationary policy will 'succeed' (they are so far correct, as Japan's money supply has actually continued to grow very slowly - the yen has crashed on perception alone, and because some of the euro area crisis related 'risk premium' was priced out of it). Should they change their mind, the enormous JGB market could easily collapse in a panic. This would not only render the government insolvent, but also the country's banks.

(click to enlarge)

A daily chart of the 10-year JGB yield - it continues to look bullish to us. Stay away from JGBs


Abenomics has nothing to 'teach us', in spite of the fact that it is currently politically popular. All the lessons that could possibly be learned from it have been taught on numerous past occasions already.

Neither mercantilism nor inflationism are economic policies worth emulating. Sound economic theory has exposed the fallacies of these policies long ago. The fact that a number of Western economists endorse them is not a reason to believe that such policies have magically become better since they were last tried. On the contrary, endorsement by Western mainstream economists is actually a grave warning sign. It is of course quite likely that an educationally valuable moment will happen down the road, namely in the form of a major currency and debt crisis. It is deplorable that all the lessons we should have learned ages ago apparently have to be retaught over and over again.

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