#18. Japan’s road to ruin

The Japanese Economy

First there was Mellonomics, associated with inter-war US Treasury Secretary Andrew W. Mellon. Then there was Reaganomics, essentially a 1980s version of the same thing. Simultaneously there was Rogernomics, attributed to New Zealand finance minister Roger Douglas. In the 1990s, inevitably, came Clintonomics.

All of this left me wondering whether I might earn immortality by inventing the next such term. I wondered about Pharaoh-nomics – an ancient Egyptian philosophy based on turning the entire economy into a pyramid scheme – until I realised that this is already being practised across much of the developed world.

I dismissed both Santa-nomics (a policy based on free gifts) and Popeye-nomics (adopting spinach as a currency) on the grounds that they were just too silly. Little did I know that something even sillier than Santanomics or Popeyenomics was waiting to stake its claim to fame.

Enter Abenomics…………

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Whilst I’m pretty sure I wasn’t the first to predict the disastrous failure of Japan’s off-the-wall economic experiment, I doubt if many have been more emphatic about it than I have. The latest flow of news from the Land of the Sinking Economy Rising Sun confirms that Japan is moving ever closer to the precipice. It’s easier for me than for others to take this view, of course, because I have access to a surplus energy economics model which shows that there is absolutely no way out for the Japanese economy.

For any student of economics, Abenomics is a marvellous example of how to get absolutely everything wrong at exactly the same time. It’s also a classic case of “be careful what you wish for”. Japanese Prime Minister Shinzo Abe has made it clear all along that he wants higher inflation and a weaker yen. As soon as the markets come to understand what is really happening to the Japanese economy, he’s going to get plenty of both. 

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As everyone surely knows, Abenomics is a response to Japan’s so-called “lost decade”, a period of stagnation which, in fact, has lasted for well over twenty years.

In the 1980s, Japanese asset values soared to truly absurd levels, with the grounds of Tokyo’s imperial palace once being worth more, on paper, than the entire State of California. After the bubble burst, economic output stagnated, and inflation gave way to deflation, whilst government debt soared to levels which would long since have bankrupted the country were it not for Japan’s traditionally very high savings ratio.

Described as a series of “arrows” (there’s nothing like being abreast of the latest military technology, is there?), Abenomics involves injecting huge stimulus into the economy whilst simultaneously boosting net exports by creating a sharp reduction in the value of the yen. The fiscal stimulus programme was expected to increase the budget deficit to 11.5% of GDP, whilst money printing quantitative easing of at least US$1.4 trillion effectively doubles the money supply.  

Theoretically, these policies could work in tandem, because expanding both public spending and the deficit, whilst also running the printing presses on such a gargantuan scale, is indeed very likely to undermine the value of the currency.

This, it was argued, would stimulate consumption as well as boosting exports, thus injecting two forms of growth into the economy whilst also creating some healthy inflation.

Unfortunately, it hasn’t worked out in quite the way that Mr Abe thought it would. For a start, modest increases in exports have been far exceeded by the escalating cost of imports – instead of creating a strong net surplus, Abenomics has just delivered the worst trade deficit in Japanese economic history. Growth, too, has fallen far short of expectations, coming in at just 1% in the latest quarter, a long way adrift of the 2.8% that the markets had been encouraged to anticipate.

All the time, of course, there has been further escalation in a mountain of government debt that was at eye-popping levels even before Japan implemented its exercise in economic insanity.

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There were, you see, one or two little snags that the Japanese government had somehow failed to notice when it designed its Abenomics policy. The first of these was that Japan, already one of the world’s biggest importers of energy, shut down its nuclear industry in response to the 2011 Fukushima disaster.

This is likely to have pushed Japan’s net imports of energy up from 412 mmtoe (million tonnes of oil equivalent) in 2010 to 445 mmtoe last year, equivalent to 95% of the country’s consumption. Combining this volume increase with the slump (of about 20%) in the value of the yen not only increased Japan’s import bill but also piled a lot of extra costs onto consumers – the very people, of course, who were supposed to boost economic activity by hiking their discretionary spending……

Second – and, again, apparently unnoticed by Mr Abe – the Japanese population continues to age. Reflecting this, Japan’s historically super-robust savings ratio is trending steadily downwards as people reach the age at which they need to draw on their savings instead of adding to them.

I must admit that I am baffled by the government’s apparent ignorance both of the post-Fukushima situation and of Japan’s demographic trends. Be this as it may, the combined result has involved soaring public debt, a widening deficit, a diminishing ability to fund borrowing from domestic savings, a yawning trade gap, a far smaller increase than might have been expected in consumer spending, and, needless to say, a shortfall in growth even at a time when huge stimulus has been poured into the economy.

Who’d’ve thought it?

Now, cognisant (at last….) of the limits to the ability of the state to borrow, the government is increasing its sales tax from 5% to 8%, effective 1st April. Since this tax hike was announced well in advance, it is highly likely that consumers have brought forward their spending, flattering recent figures whilst positioning the economy for a sharp fall once the higher tax takes effect.

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Modest though it may seem, the increase in sales tax marks the beginning of the end of Abenomics.

This, you see, is the first time that Mr Abe has moved his foot from the throttle to the brake. It certainly won’t be the last retreat for a government which, having put its policy foot to the floor in pursuit of higher growth and improved trade, has found itself contemplating instead an evil brew of economic stagnation, debt escalation and widening trade deficits. Factor-in the diminishing ability (and, presumably, the decreasing willingness) of the Japanese public to fill the budget deficit and you have all the ingredients for a disaster.    

This should come as no surprise, of course, to anyone familiar with surplus energy economics. If you download the chart below, you will see that Japan’s real economy, already far adrift of a financial economy inflated by borrowing, is poised to slump alarmingly.

Essentially, this is game-over.

Basically, Japan has three critical problems:

       It is a major importer of energy at a time when the energy cost of energy (ECOE) is moving inexorably upwards.

       It entered this era with far too much debt.

    It has a government which thinks that you can borrow and print your way to prosperity.

Where Japan is concerned, the writing is already on the wall. For the rest of us, the impending collapse of an economy which still accounts for close to 6% of global GDP ought to concentrate minds wonderfully.

Japan & Global

10 thoughts on “#18. Japan’s road to ruin

  1. Thank you another good blog, funny too if it weren’t so tragic.
    Do you have advice how to research short , medium and long currency forecasts ? I have read forexlive and FXstreet etc. but it seems to all involve short projections from traders who are making weekly or monthly bets. I want to understand GBP to USD to Yen and euro, how they might move against each-other. What you’ve written above, of course, has big implications for how this may pan out. Would you consider writing a blog about how the currencies may fall against each other? Best wishes.

    • Thanks.

      Forex trading has never been part of my job-spec, so I’m the wrong person to ask on the mechanics of it. I would say, though, that doing very short-term (days, hours, minutes even) trading in anything at all is massively difficult unless you’re right there on the spot. The folks on dealing desks hear everything instantly, and get the buzz as well as the facts – the rest of us do not.

      So my suggestion would be a longer-term, strategic-rather-than-tactical approach, which would incline me to think about futures.

      This said, I suspect that “Japan future” might be a contradiction in terms……

      PS For the above reasons, the blog you suggest might be difficult – but I’ll give it some thought. Of course, one implication that you might – correctly – draw from my book is that some currencies may be sucked into value-destruction.

  2. This all makes perfect if chilling sense. Perhaps you should write a post on China, to balance things out – otherwise a gleeful Beijing may invite you to become their ambassador in Japan. 🙂

    But I’m glad somebody is explaining all this, as the mainstream media seem thoroughly detached from reality.

    • Thanks, point taken! Actually, the SEEDS charts for China see growth continuing, though at very low levels, then flattening out – quite different from the precipitous plunge in the chart for Japan, downloadable above.

      As for explaining it, thanks again – actually, I’ve mentioned this before, because it has seemed to me all along that printing money, ramping up the deficit and driving your currency down isn’t a recipe for growth – least of all for an energy-importing country with an ageing population and a falling savings ratio.

      It’s always seemed obvious to me that Abenomics was daft – maybe it’s a case of “the emperor’s new clothes”?

  3. As insightful as ever, thank you Tim.

    Given that Japan is the Ghost of Christmas Future for Europe, what should we learn from the failure of Abenomics? Is the lesson that you have to (at all costs) prevent deflation getting a foothold? And/or that you need negative real interest rates to erode the debt? Or simply that (in a manner akin to EROEI) there is a maximum proportion of GDP that a government can control that becomes an event horizon, and once you’re over it things become very bad?

    • Interesting questions!

      First and simplest, of course, one cannot borrow or print one’s way to prosperity. Governments please note.

      Deflation is an interesting one. The conventional opinion is that deflation is A Bad Thing – but we’re used to deflation in conjunction with technical progress (look at how the price of computers has fallen). The theory is that customers put off buying because things will be cheaper later, but do they? – that hasn’t held back the computer industry. Deflation was widespread in the nineteenth century, because new technologies made things get ever cheaper, but the economy prospered – if something gets cheaper, you have more to spend on other things. The REAL problem with deflation is that it pushes the real value of debt upwards – even here, though, it also pushes up the real value of savings…..

      My view is that globally we have enormous amounts of “excess claims” – debt, money and other forms of financial “claim” that the real economy cannot meet. At the moment, expedients like QE and negative real interest rates are putting off the inevitable, but are also sapping our ability to save (saving = capital accumulation = investment). An economy without net investment isn’t “normal” or “healthy”, so we have an abnormal economy living on its accumulated capital assets – and that cannot go on indefinitely.

      The problem posed by 2008 was this – how could we eliminate these excess claims, which were the results of living beyond our collective means for so long?

      The problem began in the US and the UK. Next came Europe. Now, emerging economies are being tested (e.g. India, South Africa, Turkey etc). Stage 4 could be China.

      So, can we evade the logic of excess debts (and excess claims more broadly)? I’d say not – defaults are inevitable. So we put off the reckoning instead – that’s human nature. Does deferring problems worsen them? My guess is it does.

      So the financial crisis isn’t over. The weakest links in the system are the likeliest to snap. The panic raising of rates in many emerging economies looks to me like an advance warning of where that snap may occur……

    • The question is then: how long can the powers that be prevent correction taking place? I know that many countries are engaging in money printing, how much time do you think this will buy us before things come to a head?

      Is there any chance that the tight-oil boom will scale up and help fuel another last gasp of ‘growth’?

    • David – I’m tempted to say that if I knew that, I’d be rich! Seriously, though, I’m totally convinced that the powers that be are keeping the party going by printing and borrowing. That’s not a long-term answer.

      At the moment, threats are looming in the wings. One is the emerging world – countries as different as South Africa, Turkey and India have had to hike interest rates because US tapering threatens to prompt capital flight. Another is China, where debt problems are building in a menacing way. Then there’s Japan, of course.

      Go back just two or three years and hardly anyone worried about this – some of us had doubts about China, but the focus was the Eurozone. That hasn’t been solved, of course, so you’ve got the EZ, plus China, plus Japan, plus India, plus Turkey, plus…..and so it goes on.

      So, time for the crystal ball? Well, Japan isn’t viable, so look out for a failure to raise money in the bond market, or a credit rating downgrade, or a crash in the JGB market. I think Japan’s leading in this race, but China might really be in the sort of trouble that many seem to think.

      Bottom line? 1-2 years, tops.

  4. “Is there any chance that the tight-oil boom will scale up and help fuel another last gasp of ‘growth’?”

    I can help you on that one. At the moment the answer is a conclusive “no” for oil, because tight oil is capital intensive to get out, high well densities are required where you’re drilling it out, and field declines are very fast indeed. This means you can’t ramp high volume production up fast and you don’t alter the cost by much.

    Shale shale gas is no different (still subject to high well densities, cost and decline issues), but the exponential increases we’ve seen in shale gas volumes need to be considered in the light of the very low starting base: At current volumes shale gas is about 1% of global gas demand. As such it is only a game changer in relatively isolated markets (eg the US, with limited gas export options). The only obvious deal that might lower energy costs is a combination of global shale gas, LNG (that brings eg Australian gas onto global markets), and in particular a rapprochement with Iran (16% of global conventional gas reserves currently sterilised by sanctions). However, as Iran and Russia (20% of gas reserves) are fairly well aligned, and both budgetarily constrained to need very high export prices, these two alone form the basis of gas OPEC. Neither can afford to see gas prices collapse, and I can’t see the European’s embracing shale gas any time soon given their approach to energy.

    So my contribution is that non-conventional oil and gas won’t make the difference. A global collapse in demand (eg caused by a hard landing in China) could cause prices to collapse in energy & commodity markets, but the local and collateral economic damage of that would offset the benefits of lower energy prices.

    • Andrew – thanks for this, agree entirely.

      I would just add that US shale gas output will peak by 2017-18, once drilling reaches saturation, then decline very rapidly indeed.

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