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Japan Defies Hard Money Economics

by: Shareholders Unite

Japan proposes an interesting challenge to hard money economics, having embarked on seemingly massively irresponsible fiscal and monetary policies.

One has to keep in mind that these lessons, as extraordinary as they are, only apply under a very specific economic situation.

That is, they should certainly not be generalized, but they are interesting and very useful nevertheless as Japanese conditions are spreading.

We provide you with some stylized facts from Japan, which pose a considerable conundrum, especially for hard money economists:

  • Japan never experienced an economic depression despite having fallen victim to the implosion of the mother of all asset bubbles which was three times the relative size of those in the US in 1929 and 2008.
  • Japan has fallen victim to 'lost decades' and one of the worst demographic developments in the world but its economy and people are prospering and basking in full employment
  • Japan suffers from a stratospheric public debt but that doesn't seem to hinder growth, nor has it led to any loss in investor confidence in its debt or currency.
  • Japan's central bank is printing more money than any other but there is no inflation in Japan
  • Japan is at full employment but there is no wage nor price inflation
  • It's the deflation that enables Japan to be irresponsible, the inflation target should not be met.

By any stretch of the imagination, Japan's economic policy is extraordinarily irresponsible, the stuff that hard money economists warn about in the strongest language.

Here is a country that has produced very large public budget deficits for decades, and this has led to the mother of all public debt burdens, in the order of 250% of GDP.

Traditional economics would have told you that such irresponsible public finances would lead (or better, would have led long ago) to crushing real interest rates, as investors would require an ever higher risk premium in order to compensate for the increasing default risk.

These higher real interest rates would crowd out private investment as investors compete for savings, and the decline in investment would lead to an economic crisis which would greatly worsen the debt dynamics through the denominator effect.

Yet, not only is Japan seemingly paying no penalty whatsoever for its public finance extravaganza, it is positively thriving, even in the face of one of the worst demographic developments in the world, with the population actually shrinking. Its working age population peaked in 1997.

But Japan's GDP per head is growing as fast as that in the US, and it doesn't suffer from a rampant increase in inequality, there is no Japanese form of populism and little in the way of poverty. Here is Joe Stiglitz:

Along many dimensions — greater income equality, longer life expectancy, lower unemployment, greater investments in children’s education and health, and even greater productivity relative to the size of the labor force — Japan has done better than the United States.

What's more, not only is fiscal policy totally irresponsible, monetary policy is at least as irresponsible. The Japanese central bank, the BoJ is printing inordinate amounts of money. Below are the monthly BoJ purchases of JGBs, Japanese government bonds (one might keep in mind these are not the only assets that the BoJ is buying):

For reference, 10 trillion yen is roughly $110 billion USD. These are truly staggering figures far exceeding anything that the Fed (or the ECB) has done in recent times.

Yet there seem to be no consequences. Rather than the hyperinflation hard money economist warn against, the BoJ can't even meet its own modest 2% inflation target five years into this unprecedented asset buying spree in which it has come to own roughly 40% of outstanding public debt.

What's more, unemployment at just 2.8% is at a record low. All the fretting in the US about the slack, or absence of it determining what the inflationary risks are and whether the Fed should tighten monetary policy faster and sooner doesn't seem to hold in Japan.

In effect, the goals of Japanese policy makers are to get wages and prices rising at least moderately. Higher prices would lift some of the real debt burden and the policy goal of 2% inflation could help stabilize the debt/GDP ratio.

Higher wages would increase spending and get the economy growing faster, which also helps achieving the 2% inflation goal.

But despite all the irresponsibility in both fiscal and monetary policies, these goals remain pretty elusive.

The fiscal policy riddle

Deficit spending has been Japan's main way to avoid a 1930s style depression after several epic asset bubbles (in stocks, land, and real estate) burst in the early 1990s. These asset bubbles, and their subsequent implosion were three times as large as those in the US in 1929 and 2008.

These bursting asset bubbles demolished corporate and bank balance sheets and their response was to drastically increase savings. These savings would have sunk the economy if they wouldn't have been used by the public sector.

By national accounting identities, public and private savings together equal the trade balance. Given that the latter remained positive, one can see that Japan still had excess savings, despite the public sector being a large dis-saver.

Richard Koo from Nomura has argued that Japan's GDP would have declined by 40% if the public sector had not embarked on deficit spending. Here is Koo (our emphasis):

Japan could have found itself in a similarly devastating depression as a result of the ¥30 trillion a year in debt paydowns, the equivalent of 6 percent of Japan’s GDP, that were made by the businesses during the 10 years of 1995–2005. In addition, Japan’s household sector was saving roughly 4 percent of GDP a year. The combination of these two forces could have cost Japan’s economy 10 percent in GDP a year, the same cost the U.S. economy endured during the Great Depression. Moreover, Japan’s land prices—commercial real estate, in particular—fell 87 percent from the 1990 peak. Real estate and shares together lost ¥1,500 trillion in market value, which is roughly equivalent to three years of Japan’s GDP and is the largest loss of wealth ever experienced by any nation during peacetime.

Koo put these devastating figures into a graph:

Koo has argued that the post-bubble deficit spending is "probably one of the most successful fiscal or economic policies in history."

It's actually difficult to disagree. While the end result is a very large debt/GDP ratio (nearly 250%), in the absence of deficit spending this could very well have been much worse.

GDP falling 10% a year, imagine what that would have done to the debt/GDP ratio. Well, we know sort off, because that's what's been happening to Greece (and for a much shorter period).

Despite two debt restructurings and three bail-outs, the end result is a ravished economy, an impoverished population and debt at 180% of GDP. Japan has fared incomparably better. And there are other implications, here is Koo again (our emphasis):

The first lesson that Japan can thus teach the rest of the world is that no matter how serious a bubble’s bursting might be, if the government takes quick fiscal action and maintains that fiscal stimulus, it is possible to keep GDP from falling. And I believe that countries around the world actually learned this lesson. In an emergency G–20 meeting in Washington, DC, in November 2008, Taro Aso, the Japanese prime minister, used the chart in Figure 7 to convince the United States and the other 17 countries present that although Japan suffered an 87 percent decline in asset values, it was able to keep its GDP from falling. A lot of skeptics were in the crowd, but in the end, everybody agreed to a policy of fiscal stimulus.

But there is all that public debt. Enter monetary policy.

The monetary policy riddle

The BoJ was late in reacting to the bursting of the bubbles, but eventually it slashed interest rates to zero. But of course this doesn't really help when the private sector is paying off debt and banks don't want to lend because of the damage to their balance sheets done by borrowers in distress as a result of the asset implosions.

Things got more interesting with Abeconomics, when the BoJ started to buy very large quantities of JJBs (and other assets). As we have described above, this was (and is) on a scale that vastly exceed what the US, UK and EU have done, and for a considerably longer period (it's still ongoing).

We have seen the warnings in the US with open letters to the Fed from hard money men speaking about debt monetization and the risk of hyperinflation but Japan doesn't suffer from inflation at all, let alone hyperinflation, despite being at full employment.

Why is this so? Well, the part until 2005 is the easiest to explain, despite zero interest rates, companies were deleveraging, paying off debt rather than engage in new borrowing:

Monetary expansion works through credit creation, if there is no net credit creation, nothing much happens. But by 2005, the Japanese deleveraging had come to an end and the BoJ's asset purchasing program had yet to start (apart from a brief period of much smaller purchases in the early 2000s).

Basically QE is just an asset swap where government securities are changed for bank reserves. Both are basically interest free, the economic consequences are basically rather limited.

Banks could use these additional bank reserves to expand lending, but that presupposes that there is increased credit demand. With corporate Japan sitting on some of the largest cash mountains in the world, and households not very eager to increase borrowing, basically nothing happened.

In the meantime, the BoJ is gobbling up more debt than the government can issue, accumulating almost 40% of outstanding public debt in the process. While not directly buying at the point of issue, this is debt monetization in all but name.

So while the fiscal policy has rescued Japan from a 1930s style depression it did leave a large problem in the form of an enormous debt load which, especially given Japan's terrible demographic development, looked like an insurmountable problem.

But the sharp edges seem to have been cut away by the BoJ debt monetization even here, this is quite a remarkable development.

Bond vigilantes

It is remarkable that the notorious bond vigilantes haven't reared their heads. One could argue that this is exactly because the unprecedented BoJ purchases and you would have a point.

However, these purchases only began in April 2013 (apart from a brief period in the early 2000s when the purchases were much smaller). From the end of the bubble years until that point, bond vigilantes didn't exactly rear their heads and Japanese yields have fallen in line with those of the rest of the developed world.

Here is what hard money people expect to happen next, from Goldrepublic:

Of course, consumer prices might start rising indirectly because the bond holders that sell government bonds to the central bank could spend their proceeds on products and services that are part of the consumer price index. But it is more likely that these proceeds remain in the financial sector and will be used to, for example, push stock prices or other bond prices to new highs. The only possible answer to the question posed above is a loss of confidence in the respective currency, or a “crack-up boom” as the economist Ludwig von Mises once called it. It is the complete collapse of a currency because people no longer believe that the currency will maintain its value in the future.

Yet this isn't happening either. The yen still keeps rising in times of international crisis, which testifies to the fact that its role as international safe haven currency is undiminished.

And as long as the yen maintains it's internal and external purchasing power, there is little reason to panic and cause this "crack-up boom," as Mises called it.


The BoJ aims to get inflation to 2% as the minimum required to stabilize the debt/GDP ratio, but this goal has proved elusive, despite unprecedented amounts of asset purchases since 2013 and a still very substantial fiscal deficit.

Here is a thought. Japan might actually benefit from not achieving its 2% inflation goal. As long as inflation doesn't register as anywhere near a risk, it allows both Japanese fiscal and monetary policy to continue to be "irresponsible."

Inflation is barely in positive territory (after years of mild deflation), but as long as this stays well behaved, Japan can afford to stimulate the economy by fiscal means and cleaning up the resulting debt (and then some) by monetary means.

What you see in the figure above is that Japan was well on its way to bring its fiscal house in some order before 2008, but then the financial crisis happened and they had to start all over again.

We have heard people arguing it's a Ponzi scheme, it will all collapse, etc., basically from the late 1990s onwards. We have seen high level hedgefund managers like Kyle Bass betting against Japan's bonds or Japan's currency or both and getting smoked in the process.

The one thing (bar some major catastrophe or a replay of the 2008 financial crisis) that could dent the confidence in the yen, which has held up very well, is if credit is taking off. Here is bank credit (from Japan Macro Advisors):

It could be said to be fairly brisk in an economy with little nominal growth, but it isn't anywhere close to levels that should give rise to serious concerns.


The Japanese experience is one of the most extraordinary experiments in macro-economic policy making and offers various important insights into how economies behave in the aftermath of imploding asset bubbles, and how policy should respond.

While Japan's response has been wanting in some areas (monetary policy was slow to react, bad debts in the banking sector festered for over a decade), it got one main thing right.

That is, when the private sector is deleveraging, the only response is to let the public sector releverage. This is how Japan escaped a 1930s style depression and never even experienced anything remotely near to double digit unemployment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.