Japan's Cautionary Tale: Stimulus Without Reform Leads to Policy Cul de Sac

If one wants to see what happens when you use stimulus to help keep zombie companies alive and to resist reform efforts, look no further than Japan.

For twenty years now, Japan has been dealing with the consequences of a burst asset bubble in shares and property. And for twenty years, the body politic has been unwilling to make the necessary reforms which would eliminate zombie companies while still helping to repair balance sheets in the private sector. Instead, the Japanese have piled government deficit upon deficit like Sisyphus trying to get consumers to reflate the economy. It has not worked.

Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default".

The IMF expects Japan’s gross public debt to reach 218pc of gross domestic product (GDP) this year, 227pc next year, and 246pc by 2014. This has been manageable so far only because Japanese savers have been willing – or coerced – into lending for almost nothing. The yield on 10-year government bonds has been around 1.30pc this year, though they jumped to 1.42pc last week.

"Can these benign conditions be expected to continue in the face of even-larger increases in public debt? Going forward, the market's capacity to absorb debt is likely to diminish as population ageing reduces saving," said the IMF.

What this illustrates is that stimulus cannot be seen as a cure-all in an economy which lacks in domestic demand or in which debt burdens are high. I see this as a cautionary tale for The Europeans and Americans looking at stimulus as some magic bullet which will make structural problems disappear.

I increasingly ask myself whether any advanced democracy has the foresight to implement a targeted monetary stimulus campaign without knee-capping efforts to induce more private sector savings – fiscal stimulus is a whole different affair. Right now, the savings rate in Japan is even lower than in the United States, a direct result of easy money.

In my view, fiscal or monetary stimulus are bridges to a sustainable economic future built on the back of deleveraging, a purge of malinvestments and industry consolidation. Right now, the stimulus in Japan is looking more like a bridge to nowhere.

It is Japan we should be worrying about, not America – Ambrose Evans-Pritchard, Telegraph

Comments

[chap08:]

Edward, I think that you should make a clear distinction between fiscal and monetary stimulus. The big difference between us and Japan is monetary policy. This is fundamental. As Evans Pritchard says of Japan, "QE was too little, too late". They did nothing on monetary policy for over a decade and concentrated wholly on fiscal stimulus. Whatever else you say about the Fed, you can't say that they have ignored monetary stimulus.

So when you say "What this illustrates is that stimulus cannot be seen as a cure-all in an economy which lacks in domestic demand or in which debt burdens are high", you are not comparing like with like. You might still be right, but Japan provides you with no supporting evidence. Indeed, what the evidence does show is that, after Japan introduced QE in 2001, their economy was transformed.

Monetary stimulus is not a free lunch either of course, but I think that you are wrong to worry about the impact on private sector savings. What exactly are you worried about? Is it consumer debt? Well, for those with debt, there is plenty of incentive for this to be paid down, without increased savings rates. Increased rates only make it harder for them to achieve it. Is it the impact on investment? Fear not, there remains an excess of bank reserves and other funds to support any viable investment. Remember that the last decade has been a story of both low savings rates and massive (mal)investment.

I agree with a gloomy outlook for Japan, and for us, but the two are not the same and are being given different stimulus.

Nov 03 06:55 AM

[Edward Harr...:]

Chap, you are right, I should separate the two. The reason I am lumping them together is because they are both designed to reflate the economy and I have growing scepticism about the political process behind fiscal stimulus.

QE doesn't work - flat out. I am more supportive of fiscal stimulus. The question I have is whether fiscal stimulus is used as an excuse to not reform or reduce overcapacity as it has been in Japan.


On Nov 03 06:55 AM chap08 wrote:

> Edward, I think that you should make a clear distinction between
> fiscal and monetary stimulus. The big difference between us and Japan
> is monetary policy. This is fundamental. As Evans Pritchard says
> of Japan, "QE was too little, too late". They did nothing on monetary
> policy for over a decade and concentrated wholly on fiscal stimulus.
> Whatever else you say about the Fed, you can't say that they have
> ignored monetary stimulus.
>
> So when you say "What this illustrates is that stimulus cannot be
> seen as a cure-all in an economy which lacks in domestic demand or
> in which debt burdens are high", you are not comparing like with
> like. You might still be right, but Japan provides you with no supporting
> evidence. Indeed, what the evidence does show is that, after Japan
> introduced QE in 2001, their economy was transformed.
>
> Monetary stimulus is not a free lunch either of course, but I think
> that you are wrong to worry about the impact on private sector savings.
> What exactly are you worried about? Is it consumer debt? Well, for
> those with debt, there is plenty of incentive for this to be paid
> down, without increased savings rates. Increased rates only make
> it harder for them to achieve it. Is it the impact on investment?
> Fear not, there remains an excess of bank reserves and other funds
> to support any viable investment. Remember that the last decade has
> been a story of both low savings rates and massive (mal)investment.
>
>
> I agree with a gloomy outlook for Japan, and for us, but the two
> are not the same and are being given different stimulus.

Nov 03 09:04 AM

[chap08:]

Interesting. I don't remember seeing you make such an explicit statement on QE before. In my view it is vital in the circumstances we faced last year, or Japan have faced for so long. As I said above, the evidence says to me that QE made a significant and positive difference to Japan, when it was belatedly introduced. Their experience up to that point just showed that fiscal stimulus, Japan style, simply doesn't work. I guess my view coincides with Milton Friedman's view on what made the Great Depression i.e. it could have been avoided with the correct monetary policy.

Fiscal stimulus can theoretically work, but so much depends on the quality of the investments being made and governments don't have a great record in this regard. If you have an economy made up of 2 islands with a whirlpool between them, and your fiscal stimulus is a new bridge; then that is likely to work. More likely though, as you say above, you just get bridges to nowhere.


On Nov 03 09:04 AM Edward Harrison wrote:

> Chap, you are right, I should separate the two. The reason I am
> lumping them together is because they are both designed to reflate
> the economy and I have growing scepticism about the political process
> behind fiscal stimulus.
>
> QE doesn't work - flat out. I am more supportive of fiscal stimulus.
> The question I have is whether fiscal stimulus is used as an excuse
> to not reform or reduce overcapacity as it has been in Japan.

Nov 03 11:10 AM

[Mad Hedge F...:]

ois The collapse of the Japanese government bond market has long been the holy grail of the international hedge fund community. Unfortunately, it has remained just that for nearly 20 years, much talked about, unattainable, and some would say imaginary. During the early eighties, I took the entire pension fund of the Foreign Correspondents’ Club of Japan out of US dollar bonds and put it into JGB’s, then yielding 10%, earning the eternal gratitude of the staff there. Even today, I am showered with free drinks and lunches when I visit Tokyo. After the 1990 stock market crash, JGB’s rocketed on a flight to safety bid, the ten year eventually reaching an unimaginable yield of only 0.46%. During this decade, we have largely traded in a 1.20% to 1.90% range. Every wave of government stimulus spending brought hopes of an imminent collapse in bond prices. But the country’s gun shy institutional investors weren’t buying it, and the end result was soaring national debt, a still stagnant economy, and 1,000 bridges to nowhere, some of them truly gigantic. Hedge fund guru, Julian Robertson, annually wrote a nine figure check to the JGB market anticipating a rate spike which never appeared. However, the day of reckoning for the JGB market may at last be coming. The savings rate has dropped from 20% during my time there, to a spendthrift 3%, because real falling standards of living leave a lot less money for the piggy bank. The national debt has rocketed to 200% of GDP, and 100% when you net out government agencies buying their own securities. Japan has the world’s worst demographic outlook. Now that the country is entering its third lost decade, unfunded pension fund liabilities are exploding. I’m not saying this is going to happen tomorrow. But when the break does come, you can expect the big hedge funds to dog pile in. And if JGB’s do go down the crapper, can the yen be far behind?

Nov 03 11:22 AM

[bob adamson:]

Thank you to both Mr. Harrison and chap08 for the article and your subsequent exchange of comments. The experience of Japan over the past 20 years has become a metaphor in the significant current debate about how best to resolve the current domestic and global economic difficulties. Too often (I’m not referring specifically to the comments being posted to this article) that debate becomes a mere exchange of cautionary tales and rhetorical flourishes about the perils, on the one hand, of intervention by governments and central banks and, on the other hand, of insufficient stimulus intervention. You both are trying to look at the actual experience of Japan (rather than use a cartoon image of that experience as a straw man for debating advantage from some ideological perch).

In the circumstances of the current economic crisis the nature, form, timing and extent of fiscal stimulus and of monetary easing, the need for domestic and international structural change to industries and governance and the best and most appropriate measures and timing to bring this about and the proper role of governments and central banks (both domestically and through international coordinated action) to orchestrate, oversee and fund this transformation are all questions that need focused intelligent discussion in the general community as well as in governing circles. In short, the resolution of the crisis will be complex and multifaceted and will take time. There will be many roles and players and these roles will change at different acts of the unfolding drama.

Japan’s experience may well have been a foretaste in some significant ways of the issues now facing most of the mature economies and it is therefore great to see you two addressing that experience in its actual complexity rather than as a simplified abstraction of what not to do.

Nov 03 02:09 PM