Spending the key, says Japan's new regime
It also sowed the seeds that led to the downfall of the Noda government and - with Russia, South Korea and more recently China rattling the cage of long-running territorial disputes with Japan - helped to pave the way for the re-election late last year of the hawkish Liberal Democratic Party.
Now, with the LDP back running the show it is doing what comes naturally: boosting government spending and on Tuesday, forcing the central bank, the Bank of Japan, to swamp financial markets with even more cash.
In the process, efforts by the previous government to cut government spending, which made for gripping prime-time television as bureaucrats were browbeaten to cut outlays on pet, but wasteful, projects, have been consigned to history.
Yesterday, the BoJ caved in to pressure from the new government and committed itself to unlimited cash injections into the economy via asset purchases. And, perhaps more importantly, it has set an inflation target of 2 per cent annually in a bid to force the economy out of its long-running deflationary spiral. The caveat is that much of the new spending won't kick in until 2014.
Higher prices will force consumers to stop saving and start spending. That's the theory.
But with extreme nervousness over the outlook for economic growth that may not be easy, especially with the millions of ageing boomers headed for retirement and keen to hang on to savings for the years ahead.
And forcing the central bank to print more money may be more a case of "be careful what you wish for" since with rising prices will come higher interest rates as the yield curve begins to normalise.
In its wake, this will force down bond prices, which will leave banks and other financial institutions with heavy losses that will crimp their (financial) flexibility severely, potentially undercutting optimism of a sustained economic recovery.
It took the best part of two decades for Japan's banks to clean up their balance sheets from the excesses of the late 1980s. But just as bad debts had fallen to about 1.5 per cent of their overall loans, the collapse of Lehman Brothers and the global financial crisis took the wind out of the Japanese economy once more, with the yen surging against the US dollar.
A 30 per cent appreciation as the yen was pushed from about ¥110 to ¥77 over the past five years not only choked off exports, wiping out the long-standing trade surplus, but slashed government revenues. (It fell to ¥90 yesterday on the latest reflation package.)
Sliding tax receipts forced the government of the day to hike the consumption tax from next year, which is the last thing the economy needed - and one of the policy missteps that led to the change of government.
Domestically, some looked to the Fukushima earthquake as prefiguring dramatic changes to Japan's ways, and they may yet be proven correct. But so far, at least, there is a large element of "deja vu" about what is unfolding, with little guarantee of success.
Korea in particular has profited mightily as the yen surged, and now it is faced with a reckoning of sorts, if the Japanese export machine fires back up with a cheaper yen. Ditto for China, as it begins to look internally for growth rather than exporting its way to prosperity.
But, like a fat man on a diet, Japan cannot go without occasional binges. The trick is whether the new round of central bank money printing and government spending will lead to just spurious pork barrelling or a more fundamental revival of an ailing economy.
And the devil is in the detail, since the new unlimited central bank purchases will not kick in until 2014, with a planned ¥13 trillion of monthly purchases mostly shorter-dated paper with the broad aim of holding rates at zero. This will rise from the expected ¥100 trillion outlaid through 2013.
That extra stimulus will come just as the consumption tax is to be raised from 5 to 8 per cent before hitting 10 per cent from 2015, which may limit any potential upside.
Frequently Asked Questions about this Article…
The new Liberal Democratic Party pushed the Bank of Japan to commit to much bigger stimulus: unlimited cash injections via asset purchases and a formal 2% annual inflation target. The aim is to end Japan’s long deflationary spell by flooding markets with liquidity and encouraging higher prices.
Big-scale asset purchases can push inflation up and keep short-term rates near zero, but they also risk normalising yields later. For investors this means potential currency moves, falling bond prices as yields rise, pressure on bank profitability, and an uncertain boost to stocks depending on whether stimulus fuels real growth or just temporary gains.
The theory is that higher prices encourage people to spend rather than save, but the article notes strong nervousness about the growth outlook and an ageing population of baby boomers who are likely to hold onto savings for retirement. That demographic tendency could blunt the intended spending response.
If inflation expectations push yields up and the yield curve normalises, bond prices will fall. That creates losses for banks and financial firms holding large amounts of fixed-income securities, reducing their financial flexibility and potentially undermining support for a sustained economic recovery.
Yes — the article warns the outcome is uncertain. The danger is that extra government spending becomes short-term, politically driven projects rather than structural reforms that revive productivity and long-term growth. The real test will be whether stimulus leads to fundamental improvement or only temporary boosts.
A roughly 30% appreciation of the yen over several years choked off exports and slashed government tax receipts, weakening the economy. A cheaper yen could revive Japan’s export machine and help growth, but it also alters competitive dynamics with Korea and China and affects multinational earnings and currency-sensitive investments.
The article notes a plan for monthly purchases around £13 trillion (mostly shorter-dated paper) as part of a larger reflation push, rising from an expected £100 trillion through 2013. Importantly, much of the new unlimited buying won’t kick in until 2014, so markets may react differently now versus when full implementation begins.
Japan plans to raise its consumption tax from 5% to 8% next year and to 10% from 2015. That tax increase could limit any upside from stimulus by dampening consumer spending, so investors should watch the timing and net effect of tax rises versus new fiscal and monetary support.
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