March 30, 2010


Japan - land of the setting sun (Martin Hutchinson, 3/31/10, Asia Times)

The budget for the year to March 2011 thus has record public spending, a record deficit and, for the first time, tax receipts covering less than 50% of public spending.

That's not good. The most notorious example of a government whose tax receipts covered less than 50% of public spending in peacetime was the German Weimar government of 1919-1923, and we know how that turned out.

Needless to say, Japan does not at present appear in danger of trillion-percent inflation, and it's worth reflecting on why not. Almost certainly, the Post Bank, which owns more than US$1.7 trillion in Japanese government debt - more than a quarter of the total outstanding - is a key bulwark of systemic stability.

In the Weimar Republic, which began with inflation already running well into double digits, nobody wanted to buy government debt at interest rates well below the inflation rate, while the government didn't want to issue debt at market rates, which would have appeared horribly expensive when the interest was subtracted from the budget balance (there wasn't much experience with high inflation then). So the Reichsbank printed more money and lent it to the government, resulting in hyperinflation.

In present-day Japan, most of the deficit is financed through domestic savings, whether directly or through the intermediation of the Post Bank. The Post Bank group has $3 trillion in financial assets, more than enough to ramp up its holdings of government bonds. To limit the danger of it running out of money, the government has now doubled the limit on postal savings accounts, to 20 million yen (US$220,000) per person. Thus the mechanism by which savings are channeled into the government's coffers is extremely efficient, and in the short term offers no danger of hyperinflation.

There are two dangers here, both of them very bad news for the Japanese economy. Domestic savings may become inadequate to fund the deficits (currently running at $500 billion a year) even with the help of the Post Bank - after all even at its current gigantic size, 50% larger than Bank of America, it could finance only 2ฝ more years of deficits at their current rate before finding itself with 100% of its assets in government bonds and no money. In that case, since Japan's debt-to-GDP ratio would then be so high that foreigners would see a severe risk of default, the Bank of Japan would have to monetize the deficit. Very quickly, Japan would be into Weimar territory - in those extreme circumstances it would probably transition from price deflation to triple-digit inflation within no more than 18-24 months.

The opposite risk, even while the Post Bank was sucking in private savings effectively and funding the deficit with them, is that private business could find it impossible to get funding. After all, with deflation of 1.3% in the year to January, Japan's 30-year government bond yield of 2.27 represents a real yield of 3.57%, high in a deep recession. If the Post Bank funds the government and the private banking system cuts back lending, then the private sector is likely to become starved of funding (except for the largest exporters, which can raise money internationally).

The Post Bank, by sucking in savings and funneling money into the giant deficit maw, would be intensifying the "crowding out" of the private sector. Bankruptcies throughout the private sector would then follow, pushing Japan into ever deeper recession.

This is the true danger of Keynesian deficit spending, kept at a high rate for two decades and then intensified. "Crowding out" of the private sector becomes a truly serious problem and the economy dives into deep recession. The only solution is that found by Neville Chamberlain in Britain in 1931 (when the country, which had suffered a low-growth 1920s, was in a similar position to Japan today). He devalued the pound and cut public sector salaries by 10%, pushing hard to balance the budget through spending cuts. The result was an astonishing economic boom, by British standards. Even while world trade was deep in depression, Britain enjoyed in 1932-37 the fastest five-year growth it has ever enjoyed.

That solution, of a weak yen and sharp cuts in government spending, is the answer for Japan today - essentially Koizumi's policy, but pursued more vigorously and without Koizumi's hesitation. The policy must be kept in place until full recovery occurs and the public debt is reduced to a manageable level of around 100% of GDP - for at least a decade, in other words. Given the dominance of the high-spending forces within the DPJ, and their adherence to Keynesian nonsense, Japan is unlikely to get any such policy from the current government - Fujii, who might have attempted it, is 78 and in poor health.

Bill Emmott explained why its high savings rate was disastrous, rather than advantrageous, for Japan twenty years ago.

Posted by Orrin Judd at March 30, 2010 6:02 AM
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