Turning Japanese

by daniel archibald


The Japanese economy was the miracle of the '60s and '70s. Rapid economic growth throughout this period led to Japan becoming the second largest economy in the world at about half the size of the US by the end of the 1990. This growth was fuelled by its manufacturing sector with Japanese cars and electronics being highly sort after by the rest of the world. By 1995, the Japanese economy had expanded further with most economists predicting that it would eclipse the US in the early 21st century. This would not come to pass, with the Japanese economy hit by multiple headwinds since and shrinking to about a quarter of the size of the US and less than half the size of an emerging China. 

So what went wrong? The early economic growth of post-war Japan was boosted by strong investment into manufacturing excellence and a relatively cheap currency. The economy faced its first hurdle when the Japanese central bank was coerced to remove its USD-peg and float freely in 1985. Over the next 4 years, the Japanese Yen doubled in value, forcing its largest companies to become more productive so as to maintain competitiveness. The central bank also helped its exporters by slashing interest rates. 

This led to a huge jump in Japanese asset prices with Japanese equities and Tokyo property prices more than tripling in a relatively short period. Much of this growth was fuelled by cheap money, which saw bank and corporate balance sheets grow with debt significantly. While the Japanese central bank attempted to deflate the asset price bubble by pushing interest rates back up, it was not enough to avoid a full blown price crash. By 1992 the Nikkei had fallen 50% from its 1989 high. And by the GFC, the Nikkei had fallen over 80% from its peak. The market has now recovered somewhat, clawing back half of its total losses. 

From 1992 to the year 2000, the Japanese central bank looked to add stimulus to the economy by cutting interest rates down to zero. This aided in some recovery, but the Asian economic crisis of the mid-90s hampered any significant bounce back of the Japanese economy to its glory days. 9/11 and the 2011 Japanese earthquake and tsunami also have had significant impacts. The other major factor holding back growth has been the declining birth rate and aging population. 

Japan has maintained its zero interest rate policy now for most of the past 20 years. The central bank has also expanded its balance sheet (i.e. quantitative easing) by a factor of almost 5-fold since the GFC. Furthermore, the government also engaged in large fiscal stimulus measures as well, with its government debt leading the world at over 250% of GDP. This has helped GDP growth to be steady and pushed unemployment down to about 2.5% (i.e. full employment).

With extremely low interest rates, excessive money printing and rampant government spending, the big question is "Where is the hyperinflation?". Most other countries that have gone down similar paths, for much shorter periods of time, have been hit quite quickly by a huge depreciation in the currency and out of control prices. However, the yen is relatively stable and prices have gone nowhere in over 20 years (i.e. no inflation to be seen). This flies in the face of most economic thought.

So what is happening in Japan to allow them to maintain such high levels of money printing and government debt? And is this a pathway that other economies can take?

Firstly, even though the government may be spending more than they tax, and thus pumping money into the economy, on the other end of the scale individuals and businesses are not spending. Essentially, the money spent by government is being saved by the private sector who invest much of this savings into Japanese government debt. It's a somewhat closed loop which means that there is less pressure from outside investors. Secondly, this also explains the low inflation, as a high proportion of the economy's income is not being consumed. Lastly, the closed nature of these cash flows can also allow the currency to be largely unaffected. 

This is an overly simplified account of the mechanics of Japanese money supply and economics, and it probably will not be a good guide for other nations to follow. Australia is in the process of heading towards zero interest rates, but at least the fiscal side of things is moving towards a surplus. Following the Japanese experience, the US has shown how large budget deficits (and trade deficits), along with low interest rates, can be maintained without inflation rearing its head. Overall, the US and other developed economies may well be on the same path as Japan; just a decade or so behind.



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