Peter Tasker

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Abe Gets His Ya-Ya’s Out


by

Peter Tasker

by

Peter Tasker

Newsweek Japan 16/1/2013

Is Japan without the LDP unthinkable, like Switzerland without the Alps or the Rolling Stones without Mick and Keith?

It’s starting to look that way. As former Prime Minster Nakasone predicted, the Democratic Party of Japan has melted away like soft ice-cream in the summer heat, leaving a small white puddle on the pavement.

The LDP is back in business, as if it had never been away.

Yet this is the same LDP that presided over the two lost decades and was comprehensively rejected by voters in 2009. In the words of the Bible, can the leopard change its spots?

In this case, it might. All depends on whether Prime Minister Abe can resist pressures to compromise and actually implements the pedal-to-the-metal growth policies he has promised.

If he pulls it off, he will go down in history as the man who led Japan out of deflation and increasing irrelevance. If he defers to the bureaucrats, then his administration will probably end up as another gooey mess on the pavement.

It’s an unusual honour for a Japanese politician to have the suffix “nomics” attached to his name. There was no “Nodanomics,” not even a “Koizuminomics.” Yet even before Prime Minister Abe took office, the world’s financial markets were buzzing with excitement about “Abenomics.”

Such was the level of anticipation that between the calling of the general election and the New Year the Nikkei Index surged twenty percent. Without lifting a finger, Japan’s new prime minister had conjured into existence fifty trillion yen of financial wealth.

This was doubly strange when you consider that Prime Minister Abe is a known quantity. During his earlier brief term in office, he had no major accomplishments to his name and showed little interest in new economic ideas. So what has changed? Why should Abe.2 succeed whereAbe.1 failed?

What has changed is the entire world, and Mr. Abe is one of the few Japanese politicians to notice. Everywhere growth has become scarcer and much more valuable. You need to use all means available to secure any at all.

Before the Lehman shock of 2008 the global economy was motoring along at a steady growth rate of 4-5% with almost no inflationary pressures. It was a golden age of globalization, as the BRICs countries boomed and living standards rose in the rich countries too.

Japan’s domestic economy remained feeble, but the big manufacturing companies benefited from strong demand everywhere and a yen –dollar rate that was stable in the 100-120 range. Junichiro Koizumi, prime minster at the time, adroitly surfed the wave of good news, winning plaudits at home and abroad for w a Thatcher-style resuscitation of the Japanese economy.

Unfortunately we were all living in a fool’s paradise, Mr. Koizumi included. Serious imbalances and distortions were building up, such as the US real estate housing bubble and the divergence of the Eurozone countries. The volcano finally blew in 2008,and for a whole it looked as if the world was on the brink of a 1930s-style depression.

Though Japan had nothing to do with the sub-prime fiasco, it suffered the greatest damage – a decline of 8% in output. The idea that the Koizumi reforms had put the Japanese economy on a sounder footing was comprehensively discredited. If anything, Japan had become more vulnerable to external events than before. While large companies were making good profits in overseas, the growing hordes of part-time workers lacked the spending power to bolster domestic demand.

Since then the world has had to become accustomed to “the new normal” – which means much weaker growth in the developed world and a big slowdown in the BRICs countries too. Consumers are paying down debt. Companies are piling up cash rather than investing. Commodities prices are no longer rising and in many countries real estate prices have fallen substantially.

How long is the new normal going to last? Nobody knows, but the example of Japan is often cited as an awful warning. Policy-makers have searched frantically for new tools to avoid the fate of “turning Japanese” and suffering decades of weak growth and deflation.

Since inflation and deflation are monetary phenomena, the main emphasis has been on monetary policy. The US Federal Reserve under Chairman Ben Bernanke was the quickest and most aggressive in its response, launching wave after wave of quantitative easing.

Right from the start, the policy was controversial . Conservatives blasted Bernanke for irresponsible debasement of the currency. Texas governor and presidential contender Rick Perry went so far as to call Bernanke’s policies “treasonous” and warned that he would be “treated ugly” if he ventured into the lone star state.

But the critics have been proved totally wrong. The hyper-inflation they predicted never arrived. Instead the S&P index doubled, the dollar weakened, helping US exporters, and expectations of inflation recovered to the average pre-crisis level. The US economy is still far from vibrant. But it is in much better shape than Europe and Japan.

Other central banks have followed Bernanke’s lead. The Bank of England appointed the American Japan hand Adam Posen to its monetary affairs committee. Acutely aware of Japan’s policy errors, he was vocal in recommending aggressive quantitative easing.

Again this was controversial. Other members of the committee worried about inflation, and the consensus was that the economy would recover soon anyway. Posen was proven right. The UK economy was much weaker than expected and inflation failed to accelerate.

Europe eventually followed suit. In order to prevent a break-up of the euro, the European Central Bank was forced into large-scale purchases of bonds issued by weak borrowers such as Spain and Greece. Even more remarkably, Switzerland, famous as a bastion of monetary conservatism, made a 180 degree change in policy in order to stop the franc appreciating any further and damaging its exporters.

Incredibly, the one country that has done nothing to avoid turning Japanese has been Japan itself. Almost every Japanese administration this century made the conquest of deflation a policy priority, but no progress was made. The reason is simple. Thanks to defects in the laws that gave the Bank of Japan independence in 1998, the central bank is essentially unaccountable.

The Bank of England and the European Central Bank have explicit inflation targets. America’s Federal reserve has a legal mandate to support the growth of the economy and has recently established a new benchmark of a lower unemployment rate.

Uniquely in today’s world the BoJ sets its own targets and assesses its own performance. Not surprisingly the BoJ judges that it has been doing a wonderful job. Few outsiders would agree. As long ago as 1998, the legendary economist Milton Friedman blamed Japan’s economic problems on “a decade of inept monetary policy.” It’s not hard to imagine what he would be saying if he were alive today.

Deflation has been allowed to entrench itself for so long now that it will be no easy matter to change the attitudes of Japanese consumers, businesses and investors. Recent academic work has stressed the need for powerful messages to change expectations.

One important tool of communication is the appointment of key personnel. If the next governor of the Bank of Japan is grey ex-bureaucrat , that would suggest that the old regime remains intact. Alternatively it would send a powerful signal of commitment if someone like Mr. Posen were appointed to the monetary policy committee

Monetary policy is not the only choice that Japan has got badly wrong. Raising the consumption tax in an economy that is chronically short of demand is the road to disaster. If anything, Japan should be taxing corporate and household savings – which get a tax-free gain via deflation – instead.

Somehow the Ministry of Finance persuaded the leaders of the DPJ that Japan would be “the next Greece” unless taxes were hiked. In reality there are no examples of a sovereign debt crisis anywhere in the world today. Greece, Spain and the rest gave up their monetary sovereignty when the joined the euro. Now they are in the same position as the town of Yubari in Hokkaido which went bankrupt some years back.

In contrast, countries that issue their own money – whether developed or developing, with current account surpluses or deficits – are enjoying the lowest borrowing costs in centuries. Japan has the lowest of all. The Ministry of Finance has a golden opportunity to issue more and more bonds at extremely favourable terms. They should try issuing 100 year bonds as Mexico has done, or perpetuals as Britain has done to finance its wars.

The idea that Japan has” too much debt” is at best half-right. On one side of the balance sheet is debt; on the other side are savings. Every time a saver deposits money at a bank, the bank lends the money on. Usually that would be to companies, but if companies don’t want to borrow because they see shrinking demand, then banks have no choice but to lend to the government.

So Japan’s “excessive” debts are balanced by equally “excessive” savings. In fact the debts are more than balanced because Japan has accumulated overseas net assets equivalent to over 50% of GDP – the highest ratio in the world.

The only way Japan can get its deficit under control is by returning to economic growth so households and companies can pay more tax out of higher wages and profits. As the last disastrous consumption tax hike in 1997 showed, you cannot get blood out of a stone.

Likewise, the ten year shrinkage of public works spending has run its course. Japan needs to upgrade its defences against future natural disasters, disperse key functions geographically and set about the renewal of infrastructure built before the Tokyo Olympics. It would be absurd to allow tunnels to collapse and quake-vulnerable structures to remain standing out of misplaced fears of rating agencies.

Some critics object that Mr. Abe has no “growth strategy” and that infrastructure investment could easily turn into pork-barrel spending. In fact growth strategies often provide camouflage for channelling money to uneconomic projects. In recent years the worst example is the absurdly high feed-in tariff for alternative energies. Windmills and solar panels are the twentieth century equivalent of the old bridges to nowhere.

Instead of trying to rig the market in favour of fashionable, feel-good projects, the government should concentrate on creating a healthy environment for the private sector to develop its own growth opportunities. That means an end to deflation, a more competitive currency, no tax hikes, stronger asset markets and a general sense of confidence in the future.

For too long it has been cool to be negative and critical of any attempts to forge a different path. The result has been the inertia and comfortable pessimism that has become the default setting of policy-makers and opinion-leaders.

The LDP, like the Rolling Stones, is a dinosaur outfit. Both lack the energy levels of their nineteen sixties heyday , but still manage to wipe the floor with the modern-day competition.

So let’s give Mick Abe and Keith Aso a chance to strut their stuff on stage one more time. With determination and luck, they may succeed in providing what Japan dearly needs – more “satisfaction.”

 

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