By Filipe R. Costa
Abenomics is inventing a “second” Japanese economy. No, I don’t mean the Japanese are embracing new technologies and processes to find new ways and means of delivering growth, but rather that the Bank of Japan’s balance sheet is on course to the same size as Japanese GDP within 5 years. Amazingly that is true.
Money printing is of course not a new story in Japan. When their economic miracle came to a sudden halt in the early 1990s, the BoJ started its own version of monetary stimulus measures to try and get things moving. In the precursor to modern QE, Japan suddenly found itself in possession of dozens of useless airports, extravagantly pointless bridges and roads to nowhere. These were all paid for by easy money policies and did nothing to arrest the structural decline Japan found itself in. Japan’s public debt-to-GDP ratio is 230%, the largest in the developed world.
Currently the BoJ holds the equivalent of £1.31trillion in assets, which is roughly equal to 35% of Japanese GDP. This figure is projected to increase to 60% of GDP by the end of 2014. After that, if the BoJ maintains its pace of printing then their holdings will surpass 200% of GDP by 2018.
This is unsustainable in the long run.
Strongly influenced by the “success” of Fed policy over the last 5 years, Prime Minister Abe pressured the BoJ to engage in its aggressive new policy. Earlier in the year it announced it would purchase the equivalent of roughly £400billion in financial assets each year. Through this massive liquidity injection the plan was drive down the yields on government debt, push investors into riskier assets and devalue the Yen, thus helping exporters.
This path that Abe’s government and the BoJ are on is fraught with risk. Competitive devaluation of currency seeks to improve the circumstances of domestic populations at the expense of foreign ones. If only one country is engaged in this practice then there is no problem, but as soon as others follow suit events can rapidly spiral out of control. And then there is the cost of imports to consider. Japan imports the overwhelming majority of its oil and natural gas. These are the key components of the country’s energy requirements. A weaker Yen means these become more expensive, which drives up inflation and stifles growth.
But extra inflation is exactly what Japanese policy makers want. Their official target is 2%pa.
The insurmountable challenge opposing this goal is Japan’s 230% debt-to-GDP ratio. Even the slightest increase in bond yields will have a dramatically adverse effect on Japan’s ability to fund its expenditure. This leaves the BoJ with no choice but to keep printing and to keep buying government debt. In the absence of long term structural solutions it is hard to see how this can end well.
Central bank actions over recent times have created massive economic distortions and monster bubbles. Money isn’t wealth. When it grows faster than output it often results in lasting periods of hyperinflation. There are increasing signs that inflation is starting to grow out of control and in the next edition of SpreadBet Magazine we examine the issue of unreported inflation. Make sure you’ve subscribed to receive it for FREE in the box top right.