Timing the key in Japan's massive gamble to revive the economy
Dan Steinbock says the monetary and fiscal expansion must end before bond holders are spooked
After two "lost decades", Japan has begun a risky monetary gamble. Abenomics has the potential to make or break Japanese savings, the Asian century and global recovery.
When the Bank of Japan concluded its highly anticipated two-day policy meeting on April 4, a new era began in Japan. As the conservative caution of the previous BOJ governor Masaaki Shirakawa faded into history, his successor Haruhiko Kuroda pledged to do "whatever it takes" to achieve the 2 per cent inflation target. The great gamble has begun.
Last December, the Liberal Democratic Party returned to leadership with Shinzo Abe as its prime minister. The LDP campaigned on a three-pillar platform of renewed fiscal stimulus, aggressive monetary easing from the BOJ and structural reforms to boost Japan's competitiveness.
The sheer anticipation of change in Japan has resulted in a sharp depreciation of the yen and an equally steep rise in stock prices. The consensus forecast for gross domestic product growth in 2013 and 2014 is now around 1.5 per cent.
Recently, the BOJ also pledged to begin open-ended asset buying, seeking to inject US$1.4 trillion into the economy within two years. It hopes to double the monetary base to 270 trillion yen (HK$19.6 trillion) by the end of 2014.
However, by targeting the monetary base, the BOJ has effectively abandoned interest rates as a target. As tax revenues have failed to cover for government expenditures in Japan, life support has become a way of life. Economic activity is sustained through excessive deficit spending. In the process, Japanese governments have piled up debt valued at US$14.6 trillion, which translates to a whopping 230 per cent of annual GDP. Yet, Japan pays less than 1 per cent interest - less than Germany.
Unlike Europe's indebted southern periphery, Japan borrows most of its money from its own people. Domestic banks and insurers have purchased 95 per cent of the sovereign debt using the savings deposits of the population.
Only a decade ago, Americans used their subprime apartments as cash machines, which created a semblance of real economic activity. Japan relies on the confidence of its people so the nation can one day pay off its debts.
In the US, the subprime machines collapsed in 2008. Japan's sovereign debt could have been sustained only another decade - until Abe's reforms. In addition to the massive monetary stimulus, Abe's reformers have resorted to a large fiscal stimulus valued at 2 per cent of GDP, to jump-start growth and foster demand. That could raise the deficit to 11.5 per cent, while public debt may soar to 245 per cent of GDP by the end of the year.
The assumption is that ageing Japan will still opt for lower-risk, highly liquid assets.
Abe critically needs the BOJ to boost nominal growth and a growth environment, to pursue fiscal consolidation in a growth environment. After monetary expansion and fiscal stimulus, the success of Abe's reforms depends on the proposed structural reforms and the overall effectiveness of the new policy thrust.
In Japan, the opposition is concerned that, if jobs and salaries increase only marginally, the new monetary policy could result in a plunge of real wages.
In China, Japanese reforms are seen as effective devaluation and the BOJ decision to double the monetary base as "blackmail" to open the liquidity floodgates. Japan's equity markets have already seen US$60 billion in foreign investment inflows since mid-November, which has pushed the Nikkei to record highs.
As the BOJ is pumping liquidity into the global economy, the threat of "hot money" will increase in Asia. If the Japanese conclude that the decline of the yen will continue and decide to move their assets abroad, the outflow could turn into an avalanche, as investor George Soros has warned.
But another risk involves timing. The current goal is to implement the fiscal stimulus this year, while fiscal consolidation is to follow in 2014 and beyond. In their zeal to take advantage of the Japanese fiscal stimulus and monetary expansion, global financial markets have ignored the stated second phase of the Abe reforms.
Tokyo's dramatic expansionary moves are expected to accelerate this year, but reverse equally dramatically the next - amid economic erosion and political friction in the euro zone, impending US fiscal consolidation, and solid but reduced growth prospects in China.
If Abe's gamble succeeds, it could reverse Japan's decline, support Asian expansion and global recovery. If it fails, it could shrink Japanese savings, slow down the proposed "Asian century" and undermine the nascent global recovery. Whatever the final outcome, the colossal gamble will speed up history.
